Credit crunch? Dress code: informal – How does it Flow?

When contradictions emerge from the surface of success, China shows its weaker side. In the case of money lending, the Central Government delivers a strong standpoint: A restrictive policy is essential to the stability of the country. Inflation is to be kept under control; money circulation should be restrained to prevent overheating of the economy. The latest data show that the inflation rate in August was 6.2% on a yearly basis, which justified the concern. However, on the other hand, you may find a combination of opposite interests: Local governments, SMEs (small & medium size enterprises), exporters and real estate intermediaries and other related parties are in desperate need of credit to expand their operations and activities. For them, China is a relentless source of profits, a goose that lays golden eggs. On the contrary, Beijing tries to curb inflation by using the traditional measures of raising interest rates and controlling the reserve requirement ratio (RRR). The latter is more common, since the former (i.e. a higher interest rate) would attract more international capitals that China does not want. Since last October, the RRR has been raised 9 times, reaching an unprecedented 21.5% for bigger banks. Who need money have no choice but to knock the door of alternative channels. Though with different names – either “informal lending” or “shadow banking” – they cater the same need of insatiable investors. A study released by the People’s Bank of China showed that more than 44% of total lending comes from non-banking sector.

Trust banks play a crucial role in supporting the system. Being not fully authorized, they act in the grey area of unauthorized lending. They collect savings, the primary source of money, and distribute them with higher interest rates for a short-term period of time. The SOEs that enjoy privileged channels to get the money, wanted or unwanted, are to be their cash cow. Given that they can address some of their profits to the trust banks, the credit crunch does not hit all companies equally. Ironically, SME’s are indirectly financed by the SOE’s.

Another fraction of the unofficial lending is done through locally-established small credit companies and the organized crime. Mafia-style activities, money laundering, unauthorized export are prosecuted by the police. Arrests for illegal banking, sharking, and corruption are common but insufficient to eradicate the problem. Opacity still lingers over the Chinese credit system. Probably Beijing is unable to fully control the situation, because the knot is too big to untie. This might lead to a sour conclusion: Beijing started a perpetual movement to produce value that cannot control. Its jurisdiction stops at the necessities of a society that become even more sensitive to profits than the original slogan “Enrich yourselves” by Deng Xiaoping.