Worried about illicit lending, China discovers a big underground bank

JUST over two years after a big unlicensed bank was last found in China, another surfaced this week. Last time the bank was based in Shanghai and operated in a small number of provinces. This time the illegal bank, which is based across the border from Hong Kong in Shenzhen, is on a far grander scale. It did business in every province of the country and its clients included state-owned enterprises and foreign multinationals. It appears to have been operating unnoticed by officials for up to eight years. In the Shenzhen area alone, it was reported to have done 4.3 billion yuan (4m) of unspecified transactions in the year and a half to May.

According to the State Administration of Foreign Exchange, the bank's clients had been borrowing mostly to buy fuel, cover deposits for land-use fees and pay export duties. But, as often happens, most of the lending was really for companies to make speculative investments in property and shares. This is what appears to have led to the bank's downfall. 

The authorities in Beijing, worried about the surge in the stockmarket and property prices in the past two years, have been trying to cool things down. They had suspected that part of the frothiness in the markets was the result of too much illicit lending. Their investigations appear to have uncovered the bank's existence.

Such banks are surprisingly common in China—although this one is a whopper. A government-funded study by the Central University of Finance and Economics cited by the South China Morning Post last year found that they lent as much as 800 billion yuan a year. Some of this goes to legitimate business. Underground banks provide as much as a third of the loans to small and medium-sized enterprises (SMEs) and 55% of the loans to farmers. SMEs and farmers are generally poorly served by the larger state banks and frequently have no option but to turn to these illegal institutions.

The state's efforts to reduce legitimate lending to cool the economy mean that illegal borrowing is likely to have grown. But the success of underground banks is also partly down to the returns they provide. With state banks offering savers paltry rates of interest, the under-the-counter ones simply offer more for deposits.

Of course, they pay better because they earn more. Most of the money these banks lend is for risky investments. As much as 90% of it is used for speculative trades in financial markets.

With stockmarkets around the world jumpy, China's stockmarket bubble continuing and 3-4% of the broad money supply estimated to be flowing underground, it is no wonder the authorities are alarmed. So many unregistered institutions risk the savings of millions being suddenly washed away.
(from www.economist.com)