Private sector financing, China style
July 18, 2010 by Jules
Fancy an 80% interest loan ?
An article in this morning's SCMP provides an excellent summary of business financing in China's coastal areas and especially Zhejiang, from which the example bellow is drawn.
[The news that Wu Ying, a billionaire businesswoman, was sentenced to death for running a Ponzi scheme sent a chill though Tu Yi and other entrepreneurs in Zhejiang province.
An intermediate court handed down the death sentence to the 29-year-old Wu in December after convicting her of taking 770 million yuan (HK$882 million) from "depositors" in a loan-sharking scheme that promised high returns. She had been offering investors a guaranteed 80 per cent annual return then lent the money out to borrowers at even loftier rates.
The harsh judgment came even though Wu's investors did not lose any money.
But what the court called a scam and a Ponzi scheme - the precise term on the mainland is illegal fund-raising - business people such as Tu call an underground bank. And they are concerned that such a draconian sentence will drive the institutions further underground, making financing nearly impossible for private businesses.
"Her business model is commonly seen here in Zhejiang," said Tu. "Underground bank loans play a vital role in boosting Zhejiang's private business. To be honest, loans from the underground banks provided a lifeline for my business."
According to National Business Daily, about 600 billion yuan flows through Zhejiang's underground banking system.
"My question is the death sentence: did Wu Ying really infringe upon the law by raising the funds and offering loans?" said Tu. "It is obvious that her way of raising money can be commonly seen in many places in Zhejiang. Everybody took it for granted that the business was okay."
Tu said the law against underground banks was not enforced, noting that some underground banks openly advertised. Moreover local governments benefited because the banks helped bolster growth and local leaders advanced in their political careers largely based on the economic achievements of their area.
The suspicion is that high-ranking officials may have thought Wu had become too aggressive in developing her business.
On the mainland, only banks, credit co-operatives, small-loan firms and consumer finance ventures can offer loans, and only banks and credit co-operatives can take deposits from individuals or from corporations.
"Illegal fund-raising" emerged as a new term in the mainland business community in 1994 when a Jiangsu businesswoman, Deng Bin, collected 3.2 billion yuan in cash in what police called a swindle. Here, again, investors lost no money. But Deng was executed as Beijing cracked down on financial crimes, fearing that illegal fundraising and underground banks would wreak havoc in the mainland's banking system.
But the business has re-emerged in the past decade as private business began to flourish in Zhejiang and Guangdong provinces.
In Zhejiang, underground banks are known as biaohui in Mandarin, an ancient term for fund-raising and lending.
The normal practice is that affiliated people in a group, including relatives, neighbours and friends, deposit money with a so-called huitou - the chief operator of the pool of the money who grants loans to members of the biaohui and charges high interest rates.
Depositors are often rewarded with handsome returns from the biaohui, though they also carry huge risks of loan defaults.
According to several entrepreneurs, privately owned firms couldn't survive much less flourish without money from underground banks.
"Cash is king," said Qian Kang, the owner of a car parts company in Ninghai, Zhejiang. "Many bold entrepreneurs would rather pay high interest rates to loan sharks so they can start their own businesses."
Underground banks have often been the only recourse for small enterprises, which have been unable to get loans from state-owned lenders.
Underground banks had been strategically important to the boom in the province's privately owned businesses, said Chen Jiali, chief of the Wenzhou division of the Zheshang Research Association, a non-governmental organisation, most of whose members are Zhejiang-based entrepreneurs.
"It is really hard to define them [as underground] since the banks have deep roots in the region, though the operators and the clients know it is a very risky enterprise," he said.
Tu admitted that the underground banks, essentially loan sharks, were greedy, charging many times the interest rates offered by banks. But he still gives credit to them for doing business in a flexible and efficient manner. "I was in bad need of a loan and they offered it," he said. "I would rather pay high interest to a bank, but they wouldn't do it."
China's commercial lenders grant credit based on guidelines set by the China Banking Regulatory Commission (CBRC) and charge interest rates suggested by the central bank.
The CBRC occasionally publishes guidelines that either instruct banks to focus on loans to certain types businesses or limit them from extending loans to specified companies or individuals.
Many mainland entrepreneurs thought Beijing was being hypocritical last year when it publicly stressed the importance of small enterprises yet actively encouraged banks to lend to state-owned giants for massive public works projects.
Beijing doled out 15 billion yuan each to the Communist Party's three major mouthpieces - China Central Television, Xinhua and People's Daily - for what it described as a move to increase China's "soft power" around the world.
Business owners like Tu see a bias against privately-owned enterprises since they have had to go it alone to survive the global financial woes without receiving help from the government.
"For us, we were sometimes forced to lean on the underground banks to keep our businesses afloat," said Tu.
On the mainland, nearly 6.5 million companies are listed at the country's business-registration authorities as privately owned, accounting for four-fifths of the total eight million businesses nationwide.
Huang Mengyu, chairman of the All-China Federation of Industry and Commerce, told Xinhua last year that not a single privately owned business had been immune to the financial turmoil.
Several Zhejiang entrepreneurs said most of the underground banks they knew were run by influential people in the region because both investors and borrowers trust them.
Car-parts company owner Qian said he had connections with Wu Ying's underground bank in Yiwu and that he chose to deal with Wu because of her reputation and financial strength.
"We only trust those who have enough power, financially and politically, to handle the business," he said. "The more powerful and influential a huitou appears to be, the more money the guy could control."
Wu, who was given the death sentence by the Jinhua Intermediate People's Court at the end of last year, is in the process of appealing to the Supreme People's Court.
According to her defence lawyer Yang Zhaodong, Wu's hopes rose when the supreme court rejected a verdict of another woman who was sentenced to death by a Zhejiang court.
"I believed the death sentence on me was not justified," she was quoted by Yang as saying. "After all, I believe the law is enshrined by the principles of fairness and justice."
Yang said the 29-year-old failed tycoon wrote a 29-page petition letter to the supreme court, in which she made detailed descriptions of the practices in running the business.
"She hoped to clarify some details in the case," the lawyer told the South China Morning Post. "We do hope the death sentence would be rejected by the supreme court."
According to the state-run China News Service, more than 20 government officials in Yiwu, including some senior civil servants, were found to have been involved in Wu's case.
She raised money from people from all walks of life offering a guaranteed 80 per cent in interest a year and 5 per cent daily return for the "investors".
Ying Jun, head of Yiwu People's Court's enforcement bureau, was among the investors, placing 4 million yuan in Wu's organisation, according to the official China News Service.
"Legal or illegal," said Tu, "the fact is that these lending practices have been the biggest boost to Zhejiang's economy in the past decades."]
Now you know the answers:
1- how is business life in China? Tough, brutish and short
2- how much of China's stimulus actually went to private enterprise: zero. The state is fast expanding a a percentage of GDP.
In: Market News