Lending in the Shadows

SCMP, South China Morning Post, 24 October 2013,

by Joe Zhang *

Twice a year I travel to Jingmen in central China to visit my parents and siblings. Last week, I was there on a new mission: to review the work of my sisters as shadow bankers.

Shadow banking is lending activities outside regular banks. Despite what some would say, it is a reputable business on the mainland. It fills a legitimate need. Despite some lingering stigma, the industry is not one I am ashamed to be in.

My elder sister, Yuqing, 59, sells red bean cakes and other snacks in Maliang, a small town along Han River. She makes about 3,000 yuan (HK$3,800) a month with the assistance of her husband, a farmer who ploughs land for neighbours with a tractor in spring and autumn. They manage to make ends meet but have saved very little for their retirement. As they have never had formal employment, they will have no social security to fall back on during their retirement.Right after I became chairman of Wansui Micro Credit in Guangzhou in mid-2011, I had tried to talk my two sisters into the same trade. Owing to a lack of experience, they refused. Six months ago, I finally figured out a way for them to actively engage in shadow banking without it affecting their current work.

Yuqing's education was very limited as she only attended primary school during the Cultural Revolution. But she knows all of Maliang's 2,000 residents and is able to judge the credibility of its street vendors and store owners.

To play it safe, I gave her 200,000 yuan to try her hand at lending six months ago. In one week, she lent out all the money to four store owners. Encouraged and pleased, she borrowed 80,000 yuan from her son, a migrant worker in Xiangtan, to increase her firepower. The new funds went to a fertiliser distributor, while her four earlier customers were in catering, and sold solar heaters and electrical goods.

Her loans were all long-term ones but recallable with a week's notice. I asked her to take notes on all money inflows and outflows. She charges 1 to 2 per cent a month, but is very flexible if her customers pay slightly less, or a week later than scheduled. She is more careful about the return of her money than the return on her money. She told me she wanted to reduce the interest rates as one neighbour was planning to send her child to school in Wuhan.

Maliang also has two banks and a credit union that are flexible in their business approaches. But they are not able to meet all the demand. Unlike formal lenders, Yuqing does not need hard collateral, and that is a big draw to her business. She is discreet and does not broadcast her private lending activities, even though they were legalised long ago.

One of her neighbours, Fongjun, is also in the lending business. Three months ago, he pulled money from a quarry operator after hearing about his gambling losses. Yuqing knew that the rumour was untrue and so lent him money to fill the gap.

My younger sister, Yunmeng, is a human resources manager at a power plant. She makes 7,000 yuan a month, a big salary by local standards. With her own savings and my money, she now has 4 million yuan under management.

Seven years ago, she got burned in the stock market, and had, until six months ago, only invested in banks' wealth management products, which are essentially the banks' way to bypass the government caps on interest rates. Currently, the government caps the interest rates on bank deposits at 3.3 per cent a year, but banks pay as much as 5 to 6 per cent on wealth management products.

Through my work, I found three trustworthy peer-to-peer lenders (P2P) on the mainland. Essentially, they match small savers and small borrowers through the internet, and stand in the middle to facilitate transactions and manage risks for the savers.

I did a fair amount of due diligence on China Risk Finance, (funded by a group of well-known American investors), Kaixindai (owned by China Development Bank and Jiangsu's provincial government) and Yooli.com (co-founded by Liu Yannan, a former vice-president of TPG, the US-based private equity firm). I became an adviser to Yooli this year.

At my urging, Yunmeng invested 4 million yuan through the three P2P operators, and plans to roll over the money to new borrowers constantly through the three platforms. She gets paid an annual interest rate of 10 to 11 per cent for her risk-taking.

While the P2P operators are not legally allowed to guarantee the safety of investors' money, they still find legitimate ways to achieve the same goal. For example, CRF charges borrowers a 5 per cent risk premium and pools the money to compensate investors in the event of a default. Yooli and Kaixindai, on the other hand, make small loans in partnerships with licensed micro-credit firms, and require their partners to guarantee the loans.

The borrowers in the P2P networks are similar to Yuqing's customers, but a bigger and growing percentage are young white-collar workers who do not mind taking out a loan for a new car or a holiday in the Philippines.

Banking on the mainland is seen as a complex business (it is) and something that governments like to meddle in (they do). However, despite that meddling, ordinary people can find a way to help themselves … sometimes in the shadows of the "real" banks.

Joe Zhang is a corporate adviser and the author of Inside China's Shadow Banking: The Next Subprime Crisis?