Concerns over a collapse in China’s underground banking sector resurface

Insolvency rumours lead to run on rural lender, raising questions about health of state-owned banks amid collapse of loan shark network

PUBLISHED : Wednesday, 09 April, 2014, 10:07am
UPDATED : Thursday, 10 April, 2014, 1:25am

As a rural commercial lender in Yancheng, Jiangsu province, grappled with a run on its branches due to rumours about its insolvency, questions about the mainland's ailing underground banking system resurfaced, leaving banking regulators red-faced.

The crisis increased the pressure on mainland officials, many of whom are obsessed with maintaining social stability.

In Yancheng, government officials pledged to crack down on rumour-mongers while sidestepping questions about the health of state-owned financial institutions.

However, several officials with Jiangsu Sheyang Rural Commercial Bank admitted that the mainland's underground banking system was the cause of the chaos.

"The thing is why so many people would buy the rumour," said Sun Haixia, a middle-aged depositor. "It's nothing unusual that we people cast doubts on the banks following the collapse of the underground banks."

Dozens of loan sharks have fled Sheyang county in recent months after their illegal businesses failed.

Li Xiang said he had been lucky enough to have benefited from the loan sharks, but he would never "deposit" money in underground banks again after learning a hard lesson about risks.

"They offered a monthly interest rate of 2 per cent, and you didn't have to work because you could get interest equivalent to a year's income if you handed them 100,000 yuan," he said. "I got my money and interest back but some of my relatives didn't."

Underground banking, also known as private lending, first gained a foothold on the mainland more than a decade ago. In Wenzhou, Zhejiang province, such illegal lending helped small local manufacturers grow fast by giving them much-needed capital.

But Wenzhou's underground banking system collapsed in 2011 when manufacturers were hit by shrinking export orders and lacklustre domestic demand.

It is an open secret in some rural areas that some of the funds flowing through the underground banking system originally came from bank loans.

Banks extended credit to qualified borrowers who then re-lent the money to loan sharks to chase higher returns, said Qian Kang, a private entrepreneur in Zhejiang.

Jiangsu Sheyang Rural Commercial Bank declined to comment when asked whether substantial amounts of its loans could have flowed to illegal private banking businesses.

Li said underground banks first appeared in Sheyang five years ago, but depositors like him never asked the loan sharks how they used their money.

"People here don't understand the banking system," he said. "We just realised that the economy was so bad that we could have lost our money if the banks went into bankruptcy."

The mainland's state-owned banks have been reluctant to lend to small businesses, preferring to focus on the needs of large industrial firms.

That has left small businesses, particularly in underdeveloped rural areas, with little alternative but to turn to loan sharks in order to borrow money.

Beijing started a trial run in Wenzhou two years ago, with the aim of legalising strictly regulated private lending. But the pilot scheme failed to bear fruit because the depressed local economy made people in Wenzhou wary of lending money.

Banking analysts warn that the worst is yet to come, with the mainland economy expected to slow down and the leadership promising to de-leverage an economy facing huge financial risks.

"Sheyang's bank run provided a snapshot of the problem nationwide," said an official with the China Banking Regulatory Commission Shanghai's branch.

"The negative effects from the widespread underground banking practices are believed to be huge, but the local banking regulators can only keep their fingers crossed that no bank runs happen in their territories," the official said.