Lessons in underground banking's toxic liquidity
It's a case of easy come, easy go - and not in a good way. Thousands of private business owners in Zhejiang province have been given an abject lesson by the suicides of several debt-ridden tycoons in hock to the underground banking sector and loan sharks.
Many are teetering on the brink of bankruptcy or have simply fled.
In Wenzhou, known as the mainland's capital of privately owned business, nearly all entrepreneurs, big or small, used the services of the underground banks, regarding them as efficient financing platforms for their cash-starved companies.
Small businesses specialising in making shoes, leather bags and cigarette lighters did not necessarily see loan sharks as evil incarnate; they've often provided the lifeblood for export-oriented factories.
As state-owned banks were reluctant to offer loans, entrepreneurs borrowed from underground banks to buy raw materials to execute export orders before borrowing again to build new facilities or hire more workers and expand their businesses.
Professor Li Jianjun, from the Central University of Finance and Economics, estimates that 800 billion yuan (HK$973 billion) in cash flows through the mainland's underground banking system.
Economic analysts and business owners attribute the capital crunch and collapse of companies in Wenzhou to tighter monetary policies as Beijing stepped up efforts to fight stubborn inflation from the middle of last year.
When Beijing rolled out austerity measures to curb easy credit and cool the economy, underground banks were affected, grappling with a liquidity problem as black market interest rates soared to as high as 10 per cent a month.
Entrepreneurs had to generate massive profits to pay off such loans, but higher raw material costs and shrinking external demand exacerbated the situation, making many of them insolvent.
But that is only half the story. How much of the cash amassed by the underground banks was lent to real business owners who properly used the funds to support or expand production?
Several entrepreneurs in Zhejiang said the unreasonably high interest rates levied by the underground banks meant that no one could afford to borrow from them from a manufacturing point of view, because profits would never be able to pay off the interest.
There are no figures to show what percentage of the loans went to manufacturers, but anecdotal evidence suggests that at least half was lent to people taking a punt on the property and equity markets in search of easy money.
What's worse, some even spent borrowed millions on extravagant cars and luxury goods to make themselves look rich and successful, making it easier to obtain further loans from gullible underground bankers.
A Ningbo entrepreneur who had business ties to several failed tycoons said at least 10 underground bank operators had fled after failing to recoup loans to rogues and finding themselves unable to repay depositors.
Some borrowers even used loans to buy drugs and go on gambling sprees. Underground banks flourished after Beijing opened up the credit taps and unleashed a 4 trillion yuan stimulus package in late 2008 to counter the global financial crisis.
But substandard credit assessment systems meant they frequently extended loans to people they were connected to or businesses without collateral.
Local governments turned a blind eye to the illegal businesses because they also benefited from the boost to local economies.
Earlier this month, Premier Wen Jiabao pledged financial support to the cash-strapped small business sector after visiting Wenzhou. He pledged more credit support and tax incentives to help ailing small businesses, and stressed the importance of the private sector.
But do Wen and other officials really know who they should rescue and who to crack down on? That remains to be seen.