Imagine yourself living in Beijing and watching the stock market rise and rise. You want to invest but don’t have enough money.
In the last year, banks have come under pressure not to lend money for stock market investments, while your friends are unwilling to risk their savings for your benefit. The only answer may be Lao Huang.
Huang has built up a thriving business providing underground loans in Beijing. He works on referral basis only, so you’d have to get his phone number from a former client or be included in a carefully chosen pool of strangers to whom Huang sends text messages offering his services.
He sounds nice and professional on the phone, much better than the people you have to deal with to borrow money from a state-owned bank.
But Huang’s professionalism comes at a price. The interest rate he charges on loans is 3% per month, and it is cumulative. He also offers an alternative rate of 10% per year for larger sums. In both cases, the interest for the first month or year is due in advance.
“This is a pool of private money. You earn from stocks, real estate or whatever you like, and we earn from you. That is the market economy,” he explains.
Terms and conditions
The minimum amount of a loan is RMB10,000 (US$1,315) and no collateral is required for loans of less than RMB200,000 (US$26,315). For bigger loans, he takes real estate as collateral.
Huang prefers to lend money to people with a Beijing hukou (residential registration). Those without it have to own an apartment in the city.
The process is simple. Huang meets the potential borrower at a public place. The latter brings his identity card and hukou certificate as well as two copies of each. After examining the identification, he hands over the cash, minus the initial interest payment, and takes away the copies.
A last resort for many, Huang’s services are “informal” and perhaps illegal.
China’s informal economy is well established. Entrepreneurs and small companies have long relied on credit associations, pawnshops and personal loans for financing. These sources of cash have been easier to deal with than banks but more expensive. The rates of interest can be much higher, and Chinese contract law allows for rates of up to four times the bank lending rate.
According to the Organization for Economic Cooperation and Development (OECD), China’s informal economy could be as large as US$1 trillion. The numbers come from surveys started by Beijing in 2003 and focusing in particular on Wenzhou, where it is possible to correlate changes in the country’s ecoomy with the amount of cash available.
For example, after a real estate boom in Shanghai, cash deposits in Wenzhou jumped. They jumped again after a mining boom in western China.
“There seems to be a large amount of money going to these places where it is more profitable to invest,” said Margit Molnar, an economist with the OECD who tracks China’s informal economy.
This year, she said, a jump in the stock market has led to a shortage of cash in Wenzhou and in the informal economy as a whole. Unable to rely on banks, potential investors are finding other sources of cash, even if it involves borrowing for property projects and then diverting the money into stocks, bringing together informal investors or going to see the likes of Huang.
The Chinese government has been ambiguous about the status of this informal economy. According to the People’s Bank of China (PBOC), the size of private financing amounted to US$12.5 billion last year. This equates to 6.96% of the GDP and 5.92% of the total amount of loans in both Chinese and foreign currencies that have been issued and not repaid yet.
“The private financing is a beneficial supplement to the financial reform,” the PBOC concluded in a 2006 report.
But the fundraising process of private financing is at times deemed to be illegal because the government fears the social unrest that scams and bankruptcies can cause.
In August, the State Council published a notice, in which it requested that all local governments “shoulder the responsibility to curb the trend of growth” in illegal fundraising. The issue will also be the focus of a committe announced earlier this year, which will bring together officials from 18 ministries under the State Council. It will draft and revise laws on fundraising activities not approved by the central bank, and work with local governments to set up monitoring systems.
Such moves are seen as a response to reports of senior citizens and laid-off workers losing their life savings as they tried to meet interest payments on unfeasible schemes. It has also been claimed that legitimate bank loans are playing a role in the growth of private financing, particularly in western China, with the money then being channeled underground in pursuit of astounding profits.
According to Guo Tianyong, a professor at the Central University of Finance and Economy in Beijing, underground loans “disturb the order of local financial markets and need to be curbed urgently.”