Soybeans and Underground Finance

Piles of soybeans. Source: Jinrong Shijie (Banking World)

China's soybean traders are taking advantage of their ability to get credit to become suppliers of cash to the underground lending market. The story is an interesting merger of several megatrends: the booming demand for imported commodities, hot demand for short-term financing at high interest rates, and financial whiz-kids gaming the strategy of steadily appreciating the Chinese currency.

The Ministry of Commerce's International Commerce News reports the story. The reporter says many ports have mountains of hundreds of thousands of tons of soybeans that have been imported faster than the market can absorb them. Warehouses in many ports are said to be nearly filled with soybeans. One analyst estimates the total soybean inventories held in ports to be 6.6 million metric tons, an historical high.

According to the reporter's explanation, "soybean banking" works as follows. A trading company with rights to import soybeans signs a contract, then applies to the bank for letter of credit, paying a deposit of 20-30%. The company gets funds to pay for the soybeans with 90-180 days to pay it back.

The soybeans are on the boat about a month, and traders sell the soybeans as quickly as possible after the beans arrive at the harbor. Once importers get cash from the sale, they still have 40-50 days before they have to repay their loan. So during this period, they lend out the funds at high interest rates on the underground financial market.

According to an individual from an oil-processing company in Guangdong, the same strategy is used with palm oil imported from Malaysia, only the degree of leverage and the time period is shorter.

According to an analyst, many traders in Shandong, Zhejiang, and Guangdong are engaged in this "soybean banking." In their eagerness to get cash, they sell soybeans below cost. They make the money back by charging interest rates of 25%-30% on the underground lending market. They also make money on the appreciation of the Chinese currency during the period before they pay back the funds.

Analysts worry that the lure of soybean banking has artificially lifted demand for imported soybeans and also inflated their price. According to analysts, domestic vegetable oil processors have been losing money since late last year. The high price of soybeans raises costs, results in losses, and reduces capacity utilization.

The overstock of soybeans and weak demand is said to be a portent of weak prices and falling imports in coming months.

This story has been rumored since early this year, but no one has described the mechanics of the strategy before. The appearance of this story in the Ministry of Commerce's news site suggests the government is not happy about the behavior. The story opens a window on the chaos that ensues when the government tries to control prices (interest rates, exchange rates, and commodity prices). Trying to hold one price rigid creates an arbitrage opportunity that clever financiers will take advantage of, with unintended consequences following quickly.