Defaults causing havoc among firms

Loan guarantee networks hit by bankruptcies in Zhejiang

Networks of loan guarantees that used to be a creative method for small private firms to get financing have turned into mires of financial havoc in the Yangtze River Delta, a growth engine of China, which is now also a main source of bad debts.

Many firms in East China's Zhejiang Province have gone bankrupt after participating in networks of credit guarantees in which loans have turned sour, a problem that has become prevalent in Zhejiang and adjacent Jiangsu Province, Zhou Dewen, president of Zhejiang Federation of Private Enterprise Investment, told the Global Times on Wednesday.

Massive bankruptcies among private firms will disrupt production and cause unemployment, undermining economic stability, he noted.

About 80 percent of bad debts in Zhejiang in the first half of the year involved firms that were in networks of guarantee, Shanghai Securities News reported on Wednesday citing industry insiders.

A loan guarantee network often involves two to five companies that guarantee loans taken out by each other. In case of default by one firm, its guarantors will be responsible for repaying the promised amount of debt.

"I have heard too many such cases [of healthy firms collapsed by a chain reaction when a firm goes bankrupt]," Chen Zhihua, chairman of Wenzhou Titan International Trading Co, told the Global Times on Wednesday.

Origin of the crisis

The government's extremely loose monetary policy, initiated after the global financial crisis, is to blame for this debt problem, Chen said.

Companies were encouraged to expand aggressively during a lending spree brought on by a massive 4 trillion yuan ($650 billion) stimulus package during the 2009-10 period, yet the government urgently stepped on the brakes to tighten credit in 2011 as inflation went wild.

At that time, guarantee networks were popular among firms in Wenzhou for helping each other secure loans.

As the economy slowed down, external demand has weakened, and this along with the government's cutting of overcapacity in sectors like manufacturing has caused many private firms to go bankrupt and default on loans, causing a chain reaction in the networks.

By the end of June, nonperforming loans (NPLs) in Zhejiang totaled 135.6 billion yuan, an increase of 15.67 billion yuan from the end of December 2013, according to the latest statistics of the local banking regulator.

Zhejiang topped the nation with an NPL ratio of 1.98 percent in 2013, official data showed.

The amount of defaults in the loan guarantee networks has evolved into a social trust crisis further weighing on the local economy, Huang Fajing, chairman of Wenzhou Rifeng Lighter Co Ltd, told the Global Times on Saturday.

Nowadays businessmen in Wenzhou are hesitant to provide guarantees for others, which makes it even more difficult for small firms to get financing, Huang said.

To make it worse, banks often demand borrowers pay back money even before loans become due, which is "deadly" for private firms, Huang said.

The current situation is "lose-lose" for both banks and firms. If a bank finds out that a corporation has shrinking assets and is in difficulties, it will choose to "kill" the firm by suing it, having its assets frozen and auctioned by the court, rather than consider whether the firm still has the ability to go on, he said.

Huang said he did not undergo aggressive business expansion as many others did a couple of years ago, otherwise he would have needed guarantees from other firms and in return, have had to offer the same service to those who help him, putting his own firm at stake for the failure of others.

Bank risks

China overtook the US to become the world's biggest market in terms of corporate debt in 2013.

Its corporate borrowers owed $14.2 trillion by the end of 2013 compared with $13.1 trillion by US counterparts, rating agency Standard & Poor's said in a June report, underlining the growing risk of China's corporate debt to the financial system.

Chinese banks granted new loans totaling 385.2 billion yuan in July, only one-third the amount in June, and the NPL ratio has jumped for 11 consecutive quarters, putting pressure on credit risk control and prompting financial institutions to be more cautious in granting credit in regions with outbreaks of bad debt, the People's Bank of China, the central bank, said in a statement on Wednesday.

To ward off massive debts from breaking out in guarantee networks, China's banking regulator notified banks at the end of July that loans being guaranteed cannot exceed the net assets of the firms, news portal caixin.com reported on Tuesday citing industry insiders.

The China Banking Regulatory Commission also requires banks to enhance due diligence efforts to prevent fraud, the report said.

However, some business owners deliberately withheld information and set up shell companies with relatives and friends to enter into mutual guarantee arrangements to obtain loans, caixin.com cited an executive of a State-owned bank in Ningbo.

Possible solutions

Banks need to be less greedy, grant grace periods to firms when loans are due, and avoid collecting undue loans during difficult economic periods, said Wenzhou Rifeng's Huang.

Once a firm improves its financial performance, it will be able to pay back debt and it will be a win-win situation for both the financial institution and the firm, said Huang.

To ease financial risks, policymakers need to set up a government-backed guarantee firm to endorse outstanding debts for large local enterprises, create a new growth engine for local economies and cut tax burdens for corporations, Yan Fengling, an analyst at Beijing Unbank Investment Consultant Ltd, told the Global Times on Thursday.

Banks need to ensure that guaranteed firms are not in the same industry as those who guarantee their loans in order to disperse risks, Yan noted.

To tackle the crisis, the key is to reestablish a social credit system, Liu Xiao, an analyst with Beijing-based Anbound, wrote in a recent research note.

In a government blueprint released in June, China aims to establish laws and regulations based on a nationwide credit reference system, and a reward and punishment mechanism by 2020.

At the end of 2013, China's credit system covered 839 million people and 1.92 million firms and organizations, but its information mainly includes banking data without records from other social and economic activities.

Before the system is completed, regions with serious credit issues can establish an information-sharing system among the commerce, finance and tax authorities to rein in fraud and toughen punishments, Liu suggested.