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28 September 2011 Economics Research

China: Rising risk in informal lending
Economics Emerging Markets
Research Analysts Dong Tao +852 2101 7469

• Informal lending has surged in China, as real estate developers and SMEs that could not get bank loans have turned to the curb market, paying a reported annualized lending rate of 14%-70% for loans. • There are no hard statistics on the total amount of informal lending. The CBRC has suggested it is about RMB3trn, while we estimate it could be as much as RMB4trn, or 8% of the formal lending market, and may be growing by over 50% yoy. • Banks, large SOEs, private entrepreneurs and individuals are all involved in this lending practice, attracted by the high ‘guaranteed’ returns. Guarantors, as intermediates, play a critical role in making the deals. • We estimate that 60% of informal loans have gone to small developers, who have refused to cut property prices in the hope that Beijing’s housing policy will be reversed soon. 20%-30% of lending is to ‘real businesses’ in the form of ’bridge loans’. • The loans to developers are at risk, in our view, as developers’ cash flows could become very stretched if home transaction volumes do not pick up soon. We do not anticipate any policy easing by Beijing. • This wild wave of nationwide informal lending could cause major problems, if it is not handled carefully and proactively by the government. Due to its underground nature, informal lending is harder to monitor, manage and fix than formal lending.

Exhibit 1: Developers and SMEs have borrowed expensively in the informal lending market
8 7 6 5 4 3 2 1 0 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Aug-11 Sep-11 6% Curb market lending rate in Wenzhou (% per month)

Source: Local newspaper in Wenzhou, Credit Suisse


in our view.000 31. there is a wide range of lending behavior.000 35.000 39.28 September 2011 The rise of the informal lending market Informal lending (or shadow banking) has surged in China over the past 12 months. but the assumption of a high level of risk is a common characteristic. guarantee companies. Parties involved in informal lending are so widespread that it would not be much of an exaggeration to call it a nationwide lending campaign. Instead. pawnshops. but the SOEs lacked compelling investment opportunities.000 31. Credit Suisse The informal lending market appeared to take off in 2010 after private entrepreneurs had sold their manufacturing businesses or real estate properties but were not keen to invest the money back into ‘real businesses’ again or put the money on deposit at the banks.000 37. or about 8% of formal lending by banks. many large SOEs started to engage in lending business too. one way or another. Of course. investment guarantor companies. and sometimes subject to criminal punishment. In 2011.000 29. operational styles and ownership patterns. Credit Suisse Source: PBoC. individuals are desperate for yields as bank deposits offer steep negative real interest rates.500 32. There is a long chain of parties related to the informal lending business that includes banks. Because the lenders are often not familiar with the borrowers.500 Mar-11 May-11 Jan-11 Apr-11 Feb-11 Jun-11 Aug-11 Jul-11 Exhibit 3: Banks have continued to provide ‘cheap’ credit to the SOEs 41. SOEs. Exhibit 2: The deposit base has shrunk in recent months 33.000 25. Hence. Banks continued to put cheap credit in the hands of the SOEs.000 30. threatening financial stability.500 31. a coastal city in Zhejiang province and an industrial hub.500 33. SOEs have added an interest rate spread on the credit they obtained and have lent the money out to other parties. These are underground activities. as most such activity is done without licenses and in violation of the regulations. through their financial arms. to informal lending. The chairman of the China Banking Regulatory Commission has mentioned that the amount of informal loans totals about RMB3trn. the proceeds were often put into short-term lending.000 Mar-09 Mar-10 May-09 May-10 Mar-11 May-11 Jan-09 Jan-10 Nov-09 Nov-10 Sep-09 Sep-10 Jan-11 Jul-09 Jul-10 Jul-11 China: Saving deposits (RMB bn) Use of credit fund: Non-financial institutions and other sector (RMB bn) Source: PBoC.000 27. who brokes the 2 China: Rising risk in informal lending . and we estimate it is probably nearer to RMB4trn. typically receiving 6%-8% ’guaranteed’ annual returns.000 23. were all related. Among the informal lenders. funding sources. entrepreneurs and individuals. Many depositors have pulled their money out of the formal deposit system and have lend it out in the informal sector.000 33. there are few hard data about informal lending. while transaction volumes in property and equity markets are shrinking. it was reported that about a dozen company failures in Wenzhou. As an illustration of and warning about the risks presented by this unregulated activity. Judging from the pace of the decline in banking sector deposits. In the meantime. in our view. we think informal lending has been growing by around 50% year on year since the beginning of this year. a lending deal typically involves a guarantor.000 32.

but in most cases they are companies. and about 20% by individuals. 20% by private entrepreneurs. many smaller developers will likely collapse over the next six months. with required reserves ratio hikes and tightened loan quotas. the large SOEs. 3w mav Exhibit 5: …while inventory levels are rising 25 20 15 11 10 5 0 Apr-09 Apr-10 Jan-09 Jan-10 Primary + Secondary residential property sales Beijing Shenzhen China property inventory months 14000 12000 10000 8000 6000 4000 2000 0 Feb-09 Jul-09 Dec-09 May-10 Oct-10 Mar-11 Aug-11 Source: Soufun. The PBoC has been taking a one-size-fits-all approach by conducting quantitative tightening. in our view. typically borrowed from a bank. Credit Suisse Source: This approach has resulted in the creation of a liquidity shortage in the banking system. As a result. forcing them to turn to the informal lending market. usually takes 3%-4% of the total lending amount as a commission.. Actual lending rates have become much higher than official lending rates. a critical deal maker. we believe the expansion of the informal lending market is a result of the fact that the formal lending institutions have partially failed to fulfill their role as financial intermediaries. Interest rates and exchange rates have been left largely untouched. The shareholders of the guarantor companies usually have RMB100mn-RMB200mn of equity. We estimate that about 60% of lending in the informal market is ultimately funded by banks through various channels (lending to SOE parent companies. in our view. the price signals for capital allocation have been distorted.e. but they are relatively small in aggregate. They pay interest rates ranging between 14% and 70% on an annualized basis. with several SOEs as their shareholders. In sum. They are generally refusing to cut prices at a time when transaction volumes have fallen sharply. Credit Suisse The lending to property developers is a particular concern. for example). counting on the hope that the government’s tightening policy will be eased soon.28 September 2011 deal and guarantees that the loan will be paid back on time. i. About 20%-30% of informal lending has been channeled to real businesses. Jan-11 Apr-11 Oct-08 Oct-09 Oct-10 Jul-08 Jul-09 Jul-10 China: Rising risk in informal lending 3 . Exposure to the property sector is a concern We believe that about 60% of the informal lending has been channeled into the property sector. in our view. is a direct result of monetary policy failure. The guarantors are sometimes connected with banks. Most Chinese developers have never experienced a bear market cycle. but the actual number could be ten times higher.000 guarantors are registered in China. Pooled money investments in specific projects are a variation. The biggest borrowers are the small or medium-sized real estate developers. Guarantors could be credible individuals. in our opinion. usually serving as ‘bridge loans’ before the actual payments are received. About Exhibit 4: Property transactions are falling… Unit s sold per week. If Beijing’s housing policy is not reversed quickly. Tightened credit conditions are the driver The surge of informal lending. Since banks still want to serve their best customers. The guarantor. many SMEs and property developers have been cut from their client lists.

or a mini-credit crisis could occur. We consider the informal lending market as the most likely short-term ‘time bomb’ facing the Chinese economy.28 September 2011 Exhibit 6: RRR hikes have curbed banks’ liquidity… 25 20 15 10 5 0 1990 1993 1996 1999 2002 2005 2008 2011 Exhibit 7: …pushing up the informal lending rate 8 Curb market lending rate in Wenzhou (% per month) China: Reserves requirement ratio (%) 21. the authorities probably do not even know how to contact the lenders and borrowers. Given its underground nature. affecting corporate balance sheets. we believe it is harder to monitor. China: Rising risk in informal lending 4 . which could possibly be more abrupt and damaging than the local government debt situation. If the debt chain were to face unexpected turbulence. but we believe something is likely to happen over the next 12 months. Credit Suisse Unlike the official lending market.5 7 6 5 4 3 2 1 0 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Aug-11 Sep-11 6% Source: PBoC. Either Beijing takes proactive and decisive measures to deal with the issue beforehand. It is unclear whether this ‘time bomb’ will go off. consumer confidence and bank asset quality. If one link in the chain fails. we believe that China would likely face a credit crunch that could significantly undermine its growth prospects and investor confidence. in our view. The widespread nature of informal lending practices also means that risks could quickly spread to every corner of the economy. In the event of a crisis. the entire debt chain is likely to collapse. the informal lending market usually has a long debt chain. Credit Suisse Source: Local newspaper in Wenzhou. We also think Beijing has a very limited ability to monitor this activity. to manage and to cure. India.voloboev@credit-suisse.EMERGING MARKETS ECONOMICS AND FIXED INCOME STRATEGY Kasper Bartholdy Head of Strategy and Economics +44 20 7883 4907 . El Salvador Lorraine White +1 212 538 4311 lorraine.mustafayev@credit-suisse. CFA +1 212 538 8889 helen. Colombia Casey Reckman +1 212 325 5570 Eric Brazil Tales Rabelo +55 11 3841 6353 Helen Parsons. Research Analyst Iana Ferrao +55 11 3841 6345 iana. Chile Nilson Teixeira Head of Brazil Economics +55 11 3841 6288 Carola Sandy +1 212 325 2471 Alexey Pogorelov +7 495 967 8772 Saad Siddiqui +44 20 7888 9464 Czech Republic. Poland Sergei Voloboev +44 20 7888 3694 Paul Fage Head of EMEA Strategy +44 20 7883 7994 paul.cervera@credit-suisse. MIDDLE EAST & AFRICA ECONOMICS Berna Bayazitoglu Head of EMEA Economics +44 20 7883 3431 berna. Vietnam Kun Lung Wu +65 6212 3418 Turkey Gergely Hudecz +44 20 7883 9589 Latam Local Markets Strategy Ray Farris Head of FX Strategy +65 6212 3412 Brazil Leonardo Fonseca +55 11 3841 6348 Strategy Daniel Katzive +1 212 538 2163 Hong Mexico.wu@credit-suisse.sandy@credit-suisse. Korea Robert Prior-Wandesforde +65 6212 3707 LATIN AMERICA ECONOMICS Alonso Cervera Head of Non-Brazil Latin America Economics +52 55 5283 3845 Russia. CFA Locus Analytics Specialist +1 212 538 5889 South Africa.chodos@credit-suisse. Nigeria Natig Mustafayev +44 20 7888 1065 China.bayazitoglu@credit-suisse. Romania Carlos Teixeira +27 11 012 8054 FX Strategy Ashish Agrawal Asia Strategy +65 6212 3405 Daniel Chodos +1 212 325 7708 daniel. Ukraine. Singapore STRATEGY Igor Arsenin Head of Latin America Strategy +1 212 325 6437 igor. Taiwan Devika Mehndiratta +65 6212 3483 Brazil Daniel Lavarda +55 11 3841 6352 Strategy Chris Argentina. Panama. Philippines Santitarn Sathirathai +65 6212 5675 Brazil EASTERN EUROPE.mevorach@credit-suisse.lavarda@credit-suisse. Kazakhstan NON-JAPAN ASIA ECONOMICS Dong Tao Head of Non-Japan Asia Economics +852 2101 7469 Malaysia. Indonesia Christiaan Tuntono +852 2101 7409 christiaan.agrawal@credit-suisse. Hungary. Kazakhstan Nimrod Mevorach +44 20 7888 1257 Managing Director Global Head of Fixed Income and Economic Research +1 212 538 6480 eric.arsenin@credit-suisse.

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