More than 600 companies were affected in yet another credit crisis in China5 July, 2012, 14:00. Posted by Zarathustra
Patrick Chovanec of Tsinghua University has highlighted for us yet another arcane corner of the Chinese banking, or shadow banking system. The “credit guarantee company” in China could well be the “China’s version of AIG”.
Credit guarantee companies, as the name suggests, provide guarantees for borrowers. Private borrowers may not be able to borrow money from banks direct because they do not have government backings, or they do not have enough assets to demonstrate to the banks that they are credit-worthy. Thus credit guarantee companies come in at this point where they provide guarantee to banks after they have verified that the borrowers are good. In return, these companies collect fees from borrowers. If the borrowers default on its loans, the credit guarantee companies, of course, have to cover the losses for banks.
But it turns out that companies often ended up guaranteeing loans for each other.
A recent story from Caixin suggests that the practice of guaranteeing loans for each other is common in Zhejiang (and by the way, Wenzhou is a city in Zhejiang, where a lot of the shadow banking activities took place), where company A acted as a guarantor of company B, and some subsidiary of company B ended up acting as a guarantor for company A. If either of the company went bust, banks would be worried about the loans they made to other companies that were guaranteed by the company that has gone bust, so banks ended up calling loans for every company in the chain, and these companies might have guaranteed loans for more companies, so more companies are in trouble.
This is exactly what’s happened. Tianyu Construction Co. went bust early this year, and because of the complex web of connections where companies guaranteed loans for each other, a large number of companies have been affected by the bust of Tianyu Construction Co. According to Caixin’s report on 26 June, 62 companies are affected to a varying degree because of the bankruptcy of Tianyu.
Sources say 62 companies, from furniture makers to import-export traders, have been affected to varying extents by the collapse late last year of Hangzhou-based property developer Tianyu Construction Co. Ltd.
The companies were financially linked to Tianyu through a province-wide, reciprocal loan-guarantee network. Tianyu’s sudden failure raised the spectre of a domino effect of defaults taking down every network participant and devastating their lenders.
|Source: Eelyy vis Wikicommons|
The most remarkable and shocking thing about this crisis is that a little more than a week after the Caixin report, the number of affected companies has risen to more than 600. That is according to 21st Century Business Herald. One of the latest victim of the crisis is a company is “Hu pai”, or Tiger, as we will call it. Tiger was a sizeable company with RMB6 billion revenue and RMB200 million profits in 2011 and it was one of the top 500 private companies in China. Tiger is, according to the report, three levels away from Tianyu in the chain of guarantees. Since March this year, Huaxia Bank, Bank of China, China Construction Bank and Agricultural Bank of China have called a total of about RMB135 million. The company has roughly RMB1.5 billion loans outstanding. According to the report, the size of the chains of guarantees may include some RMB10 billion of loans.
Of course, one would expect that the government will come into rescue again, which may or may not work this time. We don’t know yet. But the point here is that the shadow banking system has exploded in China in the past year, and no one knows exactly how large the shadow banking has grown to as many of these were illegal anyway. One should be worried that there is some systemic risk here. As this particular crisis shows, that bankruptcy of one company could lead to financial chaos in 600 companies.