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Banking goes underground on tightening

Updated: 2010-12-28 13:23

By Yu Ran (China Daily)

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WENZHOU, Zhejiang - Underground banking in Zhejiang province, with a highly industrialized economy dominated by private businesses, has boomed as State-owned banks tighten credit to fight inflation.

These gray-market lenders are particularly active in Wenzhou, which has bred a host of entrepreneurs owning factories that produce a wide range of consumer goods for export around the world. Second-quarter figures from the Wenzhou branch of the People's Bank of China showed that 89 percent of local people and nearly 57 percent of enterprises had either borrowed from or made deposits at non-bank finance companies.

"The time it takes for banks to process loan applications has lengthened from a few days to more than one month since October," said Yi Wenquan, who owns a small factory making toys in Wenzhou.

"We don't need long-term capital because we are a small business," he said. "We go to banks mostly when we need money in a hurry to cover an unexpected shortfall in cash flow," he said. "A one-month wait is too long for us."

Banks' lengthy procedures to arrange loans have forced Yi and many other owners of small businesses in Wenzhou and other parts of Zhejiang to borrow from thousands of moneylenders. Most of these are guarantee agencies, investment brokers, private fund management companies and pawn shops.

Most borrowers, like Yi, come to the gray market for quick loans at terms ranging from overnight to 30 days. With an average monthly lending rate of about 10 percent, or 214 percent a year, nobody can afford to borrow long-term on the gray market.

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The lending rates of underground banks may seem exorbitant. But they are seen as necessary to cover the high risks of making unsecured loans without collateral or background checks into borrowers' ability to pay them back.

Of course, it is impossible for just anyone to get a loan from an underground lender. The borrower has to be properly introduced by someone known to the shop.

A personal guarantee from a known customer with a recognized good credit standing in the gray market is usually needed for a first-time borrower.

Despite the lack of legal standing to enforce repayment, underground banks hire debt collectors to claim loans from debtors in arrears. "These debt collectors use methods that can be most persuasive," Yi said.

Although these underground moneylenders are not supposed to take deposits, they exploit a gray area of the law to build up a large deposit base, which is their main source of funding.

Latest figures from the People's Bank of China's Wenzhou Branch showed that deposits in the city's banks fell 3.25 percent in the third quarter of 2010 while local residents' "investments" rose 5.5 percent in the same period.

Financial experts in Wenzhou said that a substantial part of that "investment" has gone into deposits at underground banks which have been raising their "interest rates" to attract new money to fund their increased lending activities.

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