An arrangement put in place by China’s state-owned banks to help them extend credit to China’s privately owned companies is now threatening to drag that sector down. A slow economy is making the crisis worse.
On July 16 the Zhejiang Provincial Financial Office acknowledged having received a letter from six hundred private companies in the provincial capital, Hangzhou, calling for urgent help. They are in trouble because of mutual-guarantor loans they had signed.
As banks are pushing these enterprises to repay loans or are simply withdrawing loans from them, these companies are asking the state to intervene and postpone such payments for three years.
The companies are not all small fry. Among them are industry leaders and well-known names, such as Hupai Holding Group Co. Ltd., that are among the top 500 Chinese private companies.
China’s banking sector has been dominated by state-owned banks, which in the past primarily lent to state-owned enterprises, both for political reasons and to reduce risk. In recent years, however, private companies have become a major source of growth, even though these companies are still considered risky.
In order to lower the credit risk, banks require guarantors for loans extended to private enterprises. As most private enterprises are small, a loan of 50 million yuan (about $8 million) may need several guarantors. In order to obtain loans, private enterprises join hands by providing either mutual guarantors or a group of guarantors.
For example, let’s say there are six enterprises. Each needs a 50 million yuan loan, and they guarantee loans for each other. When they form a group of guarantors, the bank will extend loans of 300 million yuan, six times the loan amount that is truly guaranteed, and at much higher risk.
If any one of the six borrowers cannot pay the loan, all the six enterprises will be in trouble. This is what is happening in Zhejiang Province.
Zhejiang Hangzhou Group Co. Ltd guaranteed a loan of 30 million yuan for Rongshi Group, which in turn, guaranteed a loan of 98 million yuan for the Zhejiang Hangzhou Group.
Meanwhile, Zhejiang Hangzhou Group Co. Ltd and Zhejiang Industry Holding Co., Ltd. stood as mutual guarantors for each other for loans to each of 40 million yuan. This forms a first circle of mutual guarantors.
Then, mutual-guarantor partners of Zhejiang Hangzhou Group Co. Ltd may also form mutual-guarantor relationships with other companies. As a matter of fact, Rongshi Group has five other mutual-guarantor relations. Such circles grow bigger and bigger and, as the circles expand, so does the risk.
The Zhejiang mutual-guarantor crisis involves at least 600 companies.
A report by Furniture Association of Hangzhou indicates that in the Hangzhou furniture industry alone, there are over 100 enterprises involved in the mutual-guarantor loan crisis, with debts of more than 10 billion yuan (US$1.6 billion), and 23 financial institutions, including the Bank of China and the China Construction Bank.
How wide does this crisis extend? No one knows.
How wide does this crisis extend? No one knows.
A high-ranking bank official in Zhejiang said this problem is not only happening in Zhejiang, although private enterprises in Zhejiang account for a larger proportion of the economy than in other provinces. Also, in Zhejiang mutual-guarantor loans are used more widely, accounting for about 60 to 70 percent of total enterprise financing.
Non-performing loans in Zhejiang have increased significantly. On July 13 the Wenzhou Banking Regulatory Bureau said that since the beginning of the year non-performing loans in Wenzhou City had almost doubled—by the end of June 2012 they were valued at 18.1 billion yuan, up from 9.5 billion yuan. Wenzhou’s nonperforming loan ratio has increased continuously for the past twelve months.
The increase in the amount of China’s non-performing loans may be due to two reasons.
First, the fundamental reason is the China’s bank officials handling of risk management. They lack skill in managing risk—this is one of the main lessons to take away from the mutual-guarantor loan crisis. And irresponsible behavior and misconduct by bank officials have burdened their banks with risky deals, giving rise to non-performing loans.
A 3 billion yuan (US$470 million) nonperforming loan by the China Construction Bank was reported earlier in July. About 40-50 staff members were involved and three high-ranking bank officials were suspended from their posts.
The bad loan was extended between 2010 and 2011 to Zhejiang Zhongjiang Holding Co. when it was already in shaky financial condition. The company later went bankrupt in January 2012. The Bank of China also has a one billion yuan loan to Zhejiang Zhongjiang Holding Co.
Second, China’s economic slowdown has aggravated the mutual-guarantor loan crisis. When the economy grows fast, most companies make money. But when the economy slows, more companies face financial difficulties.
In June, China’s industrial value-added grew 9.5 percent year-over-year, drastically down compared with the year-over-year growth rate of 15.1 percent for June 2011.
In Wenzhou City, there were 615 above-scale industrial enterprises that were losing money between January and May this year, 203 more than a year ago. The amount of total loss was 1.19 billion yuan, up 100.9 percent from a year ago.
Tianlun Jian, Ph.D., writes regularly on the Chinese economy.
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