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Irregular financing channels rampant

By Mao Lijun (China Daily)
Updated: 2008-07-02 11:49

When Yuan Xing needed 800,000 yuan to start his organic farm, he turned to private lenders in his hometown for financing at a 20 percent annual interest rate.

"I knew I could get a better rate from a bank," said the 29-year-old fruit and vegetable producer. "I tried Bank of China and Industrial and Commercial Bank of China, but they didn't even want to look at my business plan."

Yuan's is not a unique experience. Many small and medium-sized enterprises now mainly rely on "underground" funding to finance their businesses as credit tightening measures have dried up bank loans.

Policymakers have been tightening the purse strings to fight inflation since last year. The benchmark interest rate has been raised six times, to 7.47 percent, and the reserve requirement ratio for banks raised 15 times since last year.

These measures have made it all the more difficult for SMEs to get bank loans, a vacuum promptly filled up by underground financing channels, said industry observers.

A survey by the Guangdong provincial government showed SMEs in the province only got 2 billion yuan in bank loans last year, accounting for only 2 percent of the loans obtained by companies in the province.

Limited credit and high bad debt percentage have also prevented commercial banks from lending to SMEs.

"A lot of small firms come to us. Only the bigger enterprises go to the banks," said an underground lender, who declined to be named. He has lent out 10 million yuan - he declined to say how he made that kind of money - at 30 percent annual interest rate.

"Interest is not an issue. They will go bankrupt if they don't get our short-term loans," he said. "Our money is available at short notice. We can deliver the cash within 24 hours, while a bank loan might take at least six months. But I am only small fry, there are bigger fishes out there with more than 100 million yuan parked in underground financing."

Li Jianjun, a professor at Beijing's Central University of Finance & Economics, said the tightening measures have made the illegitimate loan market more active.

A survey conducted by his university which was financed by the National Natural Science Foundation of China, indicates underground lending totaled 1.98 trillion yuan in 2007, equal to 28 percent of the amount banks lent.

Although underground funding helps SMEs meet their needs, it poses a threat to society as counterfeiters and smugglers also benefit from it, Li said.

And, as many small steel, cement and coal companies have turned to illegitimate funding, the country's macroeconomic tightening, aimed at limiting investment in overheated sectors, has been undermined.

Underground financing also hurts the country's financial order by skewing the official interest rate regime and siphoning off deposits from banks, he said.

In addition to threatening the financial system, underground funding also represents other potential problems as such forms of borrowing are not protected by law.

"Many a time, the borrowers cannot pay back," the private lender said. "What can you do in such cases? You just have to resign yourself to your fate."

But not all lenders give up that easily. Some can go to the extent of hiring gangs to kidnap the borrowers or their family members to recover the loan, he added.