High-Interest Loans Widespread in China

Concerns are spreading about the potential risk of high-interest underground loans in China.

Companies and families unable to get bank credit must turn to underground channels to get capital. Some companies pay off bank loans when they come due by taking out underground loans at interest rates two to three times the bank interest rate. Underground lenders are eager to give out the loans because they pay much higher interest rates than bank savings accounts. According to one financial expert, some Chinese companies have quit their primary business and devote themselves to making high-interest loans.

The underground lending industry got its start in Wenzhou, Zhejiang Province and other areas in Zhejiang and Jiangsu Provinces. Now it has spread throughout the country. A report issued by Southwest Financial University in 2013 estimated that private lending totals 8.6 trillion yuan--about US$ 1.4 trillion. They estimated that 44% of the loans were for purchase of real estate, about 34% for business and farming, and the remainder for cars, education and other uses. They estimated average financial assets of about 61,439 yuan per family and average debts just slightly lower at 60,959 yuan.

Equity markets in China are undeveloped. They are reserved largely for big state-owned companies and other big companies with good government connections. Only 8.8% of Chinese families buy stocks (12% in eastern regions and 3-4% in central and western provinces.) Small and medium companies rely on their own funds or informal borrowing to raise capital. One survey found that bank loans are predominantly short-term in duration, so they come due before company investments yield a payoff. The Southwest Financial University survey found that poor families were more likely to engage in high-interest borrowing.

A meeting of Anhui Province's Peoples Congress expressed concern about the spread of high-interest lending from neighboring provinces into Anhui and the lack of supervision. A recent article investigating conditions in Henan Province's countryside found that high-interest borrowing is widespread in some villages. In January, there was news about numerous small businesses facing financial pressure from high-interest loans in Chengwu County in Shandong. In Loudi, a small city in Hunan, a company boss was found dead after either falling or jumping off a building, and dozens of creditors descended on the company to collect high-interest loans. The company began as a rice mill in 1993 and had diversified into pomegranates and was trying to become a player in the publicity business for high-tech companies.

Government officials are among the underground lenders. Operators of grain and cotton depots have access to large volumes of funds that could be lent out at high interest rates. Some have been exposed; others likely remain undiscovered. With prices of many agricultural commodities flat or falling, these operators are ripe for trouble. A similar situation occurred in the late 1990s, the last time farm commodity prices fell.

The 2014 "number 1 document" included many ideas to jump-start rural financial services. One reason may have been to fill the void of legal financial intermediaries in rural areas and contain the explosion of unregulated underground financing. Underground lending has been big for years and it has been spreading. As long as the economy was humming, most loans got paid off. But now business has slowed down and disputes over unpaid loans are becoming more common.