Bloomberg: Why I became a shadow banker in China

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#1
Date
July 9, 2013 - 3:14PM
Comments 5
Joe Zhang
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China's shadow banking sector is estimated to be worth $5.5 trillion. Photo: Tomohiro Ohsumi
In the fall of 2010, as deputy head of China investment banking at UBS, I spoke to a group of wealthy investors in Beijing about the outlook for Chinese stocks.

A rumpled, 50-something man from Hangzhou named Wang Zhigang pulled me aside afterward and asked for my advice about investing. Until then, he had made his money through curbside lending, not stocks.

The threat to China’s financial system is right there - out in the open - not lurking in the shadows.

But, he lamented, his returns had dropped from more than 30 per cent a year to a mere 23 per cent. He worried about his personal fortune, which he had built up from nothing to almost 3 billion yuan (about $490 million back then).

He hardly needed my advice, I told him. “With your performance, even Ba-Fei-Te should farm out some money for you to manage!” I said, referring to Warren Buffett’s name in Chinese.

Intrigued, I flew to Hangzhou a few days later to find out how Wang had done so well. He drove me to the Haining Leather Market to meet some of his customers. They were merchants of leather shoes, handbags and accessories. Their network was wide and close-knit, and they sold products globally through traditional channels, as well as online.

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Twenty years ago, these guys would have looked like small fish to a traditional bank. Even after their businesses had grown exponentially, they couldn’t supply the kind of collateral that banks demanded. Yet these merchants needed money, and they needed it fast. So they turned for help to “shadow” bankers, like Wang.

Unrestrained growth

There has been a lot of talk lately about shadow banking in China. Between curbside lenders, microcredit institutions, pawnshops, trust loans, “wealth management products” from banks and other components, this murky and unregulated financial universe is now worth an estimated $US5 trillion ($5.5 trillion), challenging the dominance of the traditional banking sector.

Such unrestrained growth naturally worries China’s central bank, which fears that a flood of bad shadow loans could prompt a financial meltdown similar to the US subprime crisis in 2008.

A liquidity squeeze in June, when the central bank allowed interbank lending rates to rise to as high as 20 per cent before intervening, was widely interpreted as a warning to banks to clean up their shadow portfolios.

China’s shadow bankers are easy to demonise. Like Wang, many are nicotine-stained and seemingly unsophisticated. Their methods are unorthodox, possibly even unsavory. Their loans don’t show up on any balance sheets. They look like a disaster waiting to happen.

I believe these fears are misplaced, and I should know: Eight months after my visit to Hangzhou, I became a shadow banker myself. Since 2011, I have run a microcredit firm in Guangzhou, which provides loans to thousands of small-scale entrepreneurs: florists, restaurateurs, fish farmers, vegetable growers, roadside hawkers.

Although we charge about 24 per cent annually for our money, demand remains virtually unlimited. Our customers are too small and too unstable to get traditional bank loans. At the same time, because we keep our loan amounts small - $US20,000 apiece on average - and because we have close contact with our clients, the business has proved reasonably secure. Our bad debts have not strayed above 5 per cent since the firm was founded five years ago.

This month, I visited Wang in Hangzhou again. A few borrowers had defaulted in recent months, he told me, but unlike some of his competitors, he had been “extremely lucky.” He was scrupulous about only lending to clients and businesses he knew well, and years of experience had given him a good eye.

“This is my hard-earned money; I have to be careful,” he told me. “My family was dirt-poor when I was a child. I am just so afraid of becoming poor again.” Wang’s fortune had almost doubled since I had last seen him.

Lower leverage

One cannot defend a $US5 trillion industry with a couple of examples. Two of Wang’s colleagues had been wiped out in the last year after large borrowers defaulted. Several other informal lenders in Hangzhou had ended up behind bars after disgruntled investors accused them of fraud. In recent weeks, news reports have described mass bankruptcies among small businesses that had borrowed heavily from shadow banks at exorbitant rates.

But neither should one condemn all of shadow banking because of stories like these. Shadow banking is well diversified, and serves a legitimate customer base. By and large, it has much lower leverage than banks or corporate China. Losses at shadow banks are often absorbed by entrepreneurs themselves, without affecting the taxpayer.

Even the “wealth management products” offered by regular banks are not to be feared, because they are just deposits, pure and simple, whatever the theoretical distinctions. I buy them myself.

Certainly, the sector could stand to be brought under greater supervision. But many of the regulations already in place are vague and unreasonable. Authorities have never clearly defined something as fundamental as what constitutes “illegal fundraising.”

Microcredit operations, like ours, are allowed to borrow from no more than two banks for any more than 50 per cent of their equity capital. Why only two banks? Why only 50 per cent? These restrictions are arbitrary, and they severely limit our ability to lend to underprivileged customers.

The government and the media are scapegoating the wrong culprit. Shadow banking has flourished in China for one simple reason: financial repression. By keeping interest rates artificially low, authorities have forced savers to search for more lucrative financial products. By favoring banks - which, in turn, favor state-owned or well-connected private-sector companies with loans - they have forced small enterprises to seek out people like me and Wang.

Meanwhile, projects that might look sketchy at 9 per cent interest rates suddenly look feasible at 6 per cent. Under such conditions, traditional banks have steadily lowered their lending standards - from prime loans to subprime and then to simply silly loans.

Sound familiar? That’s how the 2008 financial crisis began, too. Leaders are right to worry about the possibility of a banking crisis in China. But instead of focusing their ire on shadow bankers, they should raise benchmark interest rates in order to reduce the amount of credit flowing to dodgy loans through the formal banking sector. The threat to China’s financial system is right there - out in the open - not lurking in the shadows.

Bloomberg
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#2
though the shadow banking is big in China, certain examples in the article are fishy.

US$20K loan to some "small-scale entrepreneurs: florists, restaurateurs, fish farmers, vegetable growers, roadside hawkers"? sure or not? these business people can't contribute US$20K to their business as equity? Instead, they are borrowing it at 24%? Why don't these entrepreneurs just earn and save the US$20K?

if it is US$20million, it is more believable.

it is possible that this is Chinese version of sub-prime. loan to someone which does not even have an income. possible?
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#3
(09-07-2013, 09:40 PM)freedom Wrote: though the shadow banking is big in China, certain examples in the article are fishy.

US$20K loan to some "small-scale entrepreneurs: florists, restaurateurs, fish farmers, vegetable growers, roadside hawkers"? sure or not? these business people can't contribute US$20K to their business as equity? Instead, they are borrowing it at 24%? Why don't these entrepreneurs just earn and save the US$20K?

if it is US$20million, it is more believable.

it is possible that this is Chinese version of sub-prime. loan to someone which does not even have an income. possible?

US 20k is about 125k RMB, and the average income of Urban Chinese citizens is about 25k RMB (approx. 4k USD). Hence this kind of lans would amount to 5 years of their income. So if we are to extrapolate it to our Singapore example, it is like a $300k loan here. So US20k loan is a respectable amount to Chinese small/mid businesses. Secondly, it is possible to loan to anyone you want even in Singapore just don't declare it on your balance sheet.
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#4
Just take everything in China with a pinch of salt... give the new leaders the next 5 years to clean up all the rubbish and see if they can rebuild the trust.

Personally, China if anything is the next cycle story (after the current bubble burst) if they can rebuild everything. China banking will come strong and furious with recapitalisation the chinese way.

Just look at all the capital flight... basically there is little core strength left domestically from a logically view (can easily forget about statistics since one can trust very little of which).

KIV and no rush...

GG

(09-07-2013, 09:40 PM)freedom Wrote: though the shadow banking is big in China, certain examples in the article are fishy.

US$20K loan to some "small-scale entrepreneurs: florists, restaurateurs, fish farmers, vegetable growers, roadside hawkers"? sure or not? these business people can't contribute US$20K to their business as equity? Instead, they are borrowing it at 24%? Why don't these entrepreneurs just earn and save the US$20K?

if it is US$20million, it is more believable.

it is possible that this is Chinese version of sub-prime. loan to someone which does not even have an income. possible?
Reply
#5
Micro financing are big (pun intended) in developing countries. It gives the poor hope and a chance at life.

http://www.amazon.com/Small-Loans-Big-Dr...0470196327
Before you speak, listen. Before you write, think. Before you spend, earn. Before you invest, investigate. Before you criticize, wait. Before you pray, forgive. Before you quit, try. Before you retire, save. Before you die, give. –William A. Ward

Think Asset-Business-Structure (ABS)
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