China Law Blog

Business and consumer lending in China is behind that in the West and its lack of development hinders both China's small and medium enterprises (SMEs) and the development of a consumer society.  China does not have good credit databases on either consumers or businesses and its heavily regulated banks are reluctant to lend money to businesses that are not large or state owned enterprises (SOEs). 

Chinese SMEs needing short term funds are often forced to borrow from pawn shops and unregulated underground lenders at extremely high rates, according to a recent Reuters News Service article.  Pawn shops in China thrive by "meeting the demand from small firms and individuals for short-term loans that China's banks, with their focus on lending to big state-owned firms, traditionally ignore."  The article notes that many banks view private firms as "too risky a proposition since they do not have state backing."  Xie Bin, head of financial research at a Chinese think-tank, says the boom in pawn shop loans speaks "volumes about the failure of China's banks to price risk properly and provide decent services to small businesses."  According to Mr. Xie, "small firms borrow from pawn shops only when they have no way out, because they must pay very high interest." Pawn shops typically charge 3.2 percent per month on loans secured by property and 4.7 percent per month on other loans. The benchmark bank lending rate is 5.58 percent per year.

Pawn shops and underground lenders give SMEs "few-questions-asked loans in just two to three days, compared with two-three months at banks."  Underground lending (this does not include pawn shops) is estimated to at 950 billion yuan, or 7 percent of GDP and 6 percent of all lending in China. China now has more than 1,000 pawn shops.

The Hong Kong Standard had an article today on how the Czech Republic's leading financial services company, PPF Group, hopes to offer consumer loans in China for electronics and appliance purchases.  PPF was a pioneer in consumer finance in Eastern Europe and it believes its experience with Eastern Europe's transition from socialism to capitalism gives it special insight into China.  PPF is convinced its consumer focus is timely since many mainlanders are coming to view China as needing to increase its domestic consumption to lessen its dependency on foreign direct investment (FDI) and exports for growth. 

PPF has already successfully "road-tested" its consumer finance model in newly capitalist Russia and "it is eager to try it out in China, where the household savings rate is nearly 50 percent and the home appliance market is worth 280 billion yuan per year, but where the idea of buying on credit is still unfamiliar to most:"  Since PPF launched its Russian business in 2002, almost seven million people have borrowed from it and forty percent of Russian home appliance purchases are now financed whereas before PPF's entry, all such transactions were in cash. 

PPF faces a big hurdle in seeking to replicate its Eastern European experiences in China: foreigners are not allowed to conduct consumer finance activities on their own.  PPF intends to solve this problem by buying into mainland banks and it is in talks with two lenders -- Chengdu City Commercial Bank and Deyang City Commercial Bank. China does not allow any one foreign company to own more than 20 percent of a city commercial bank and the ceiling on combined foreign ownership is 25 percent.  PPF hopes to conclude its negotiations with the two banks quickly, possibly in time to open a consumer finance business before the end of this year.

In China's larger cities, PPF plans to work with big appliance retail chains such as Gome and Suning.  In its smaller cities, however, PPF plans to market its loans through the appliance manufacturers.  In December, PPF signed an agreement with Changhong Electronics, one of the mainland's top TV makers, to set up a consumer loans joint venture.

PPF claims its financing has increased appliance sales by over 30 percent in Eastern Europe and it  expects the same increases in China.  PPF asserts it will be "introducing a risk management concept that is new to China - different interest rates according to individual creditworthiness."  Personal borrowers generally borrow from banks at the same interest rate, regardless of their credit history or borrowing capacity.

The government owned People's Bank of China recently announced its intention to establish a nationwide credit database on corporate borrowers by the end of June, 2006  This database will be shared by all commercial banks and some rural credit cooperatives.  At the same time it announced this database, It also urged banks to make a "special effort" to help SMEs build up their credit histories, so it will be easier for them to access loans in the future.  A rudimentary personal credit database recently came into existence.

Many large international banks, including Bank of America, HSBC, and Citibank, have already made large purchases of interests in Chinese banks in anticipation of expected end of year liberalization of China's foreign direct investment (FDI) laws relating to financial institutions.  The continued influx of foreign banks will eventually change lending in China, but in the meantime, borrowed Yuan will be hard to find.