China's Hangover

Inside the world of China’s "shadow banks"

Rob Schmitz Oct 3, 2013
China's Hangover

Inside the world of China’s "shadow banks"

Rob Schmitz Oct 3, 2013

Wherever you go in the coastal city of Wenzhou, you hear the sounds of people working, spilling out of thousands of small factories which line the streets. One neighborhood makes most of the world’s metal cigarette lighters. A couple of miles away, there’s a neighborhood devoted to shoe soles. The district beyond that? Felt tip pens.

Nearly all of them are small, privately-owned businesses getting zero help from the government. According to Wenzhou businessman Huang Fajing, this — combined with the city’s geography — has created some of the keenest businessmen on the planet.

“We’re a coastal city near Taiwan. The government was always scared Taiwan would bomb or invade us. So the government never bothered to invest any money in our infrastructure,” says Huang, pausing to take a drag on his cigarette. “They left us alone.”

Some here say the government got out of the way — allowing the capitalist-minded people of Wenzhou to develop their own economy, complete with a lending system that predates banks. A place where a loan is simply a pile of money pooled together by friends and family.

“I began making cigarette lighters 20 years ago,” continues Huang. “Four of my family members each put in $1,500 and lent it to me without interest. That’s what we call a Wenzhou loan.”

Thanks to his Wenzhou loan, Huang Fajing made a fortune selling cigarette lighters–Chinese media now call him the ‘lighter king.’

On his road to cigarette lighter fame and fortune, the Lighter King watched on as more money flowed into Wenzhou. Over time, loans were no longer limited to just family and friends. The ‘Wenzhou loan,’ says Huang, became a lot less innocent.

“Bigger groups of lenders began to form. They pooled money together and took turns taking out loans. Then they started lending money with very high interest rates – to strangers.”

This system of lending — in all its variations — is called shadow banking. It’s now popular throughout China. In a report earlier this year, JPMorgan Chase estimated China’s shadow banking industry could be worth up to 70 percent of the country’s GDP. China’s central bank has become so worried about this that in June it essentially froze lending between the country’s banks, sending global markets into a freefall. The big concern here is that if China’s economic growth continues to slow down, all these off-the-books loans won’t be paid back.

Along a busy thoroughfare in Wenzhou simply called ‘shoe street,’ shoe factories that export to Europe are now– like the EU — suffering.

Shoe factory owner Gao Shenyi sits inside his storefront sipping tea and smoking cigarettes with his friends. He wears a silver chain around his neck, bright red shoes, and a tight t-shirt filled with random English words: “staple text,” “free floral decorative pack,” “January,” and so on. The shirt’s tucked into bright white chinos, showing off a sparkly rhinestone belt buckle.

His friends are dressed like Chinese gangsters, too. There’s a reason for that.

“My friend lent some money to a businessman who agreed to pay it back with interest in 60 days,” mutters Gao, “But then the guy disappears. We’ve been looking for him, but he ran away.”

This has become common in Wenzhou. Private loan defaults have soared over the past two years. Dozens of Wenzhou businessmen unable to pay back their loans have gone missing or been found dead. Yin Zhichao, deputy director of the China household finance survey, has studied China’s shadow banking sector for years. He fears these types of defaults could lead to social instability throughout China.

“They have a sudden, far-reaching impact on everyone who’s lent that money,” says Yin. “From my point of view, China’s biggest economic risk isn’t from the existing banking system, but from this type of shadow banking.”

And now China wants to bring this sector out of the shadows. A year ago, it chose Wenzhou to start a pilot program to legalize shadow lending networks. It built a center where people can apply for these loans, with more tightly regulated oversight.

But here at the Wenzhou Private Lending Registration Center on a recent weekday, there isn’t one customer. Rows of chairs sit empty and dozens of staff pretend to look busy, surfing the Internet.

“It’s always this empty,” says Zhou Xiang, a loan officer who works here.

Zhou sits under a poster depicting a smiling elderly couple lying on their stomachs in a verdant meadow of wildflowers, admiring a butterfly collecting pollen. The sky is blue, and in the background, skyscrapers rise from the pasture. It’s a landscape that doesn’t exist in China, promising loans nobody seems to want.

“Most businesses that come here don’t have a credit history,” admits Zhou. “They just don’t qualify for a loan.”

Which is exactly how shadow banking started here in the first place.

What is shadow banking? The shadow banking system is a key component of the U.S. economy. Paddy Hirsch explains what it is. Watch the video

There’s a lot happening in the world.  Through it all, Marketplace is here for you. 

You rely on Marketplace to break down the world’s events and tell you how it affects you in a fact-based, approachable way. We rely on your financial support to keep making that possible. 

Your donation today powers the independent journalism that you rely on. For just $5/month, you can help sustain Marketplace so we can keep reporting on the things that matter to you.