China's Underground Banks

Coming together. Bank carrier. Traveling money. Splitting shares. Underground banking goes by many names in China, a measure of how resourceful investors and entrepreneurs are in a country saddled with rigid and inept state-owned lenders. The value of such transaction are estimated at between 2 to 5 percent of the country's gross domestic product, though it could be twice that much. Either way, China's private sector would grind to a halt without it.

In its most common form, gray or curb market lending in China is channeled through a hui (which translates loosely as "coming together"). A hui is an informal credit association of friends or family members who pool their savings to finance anything from a new home to a wedding reception. It is led by a hui dong, or chairman, who records deposits in a ledger book or even pieces of scrap paper. Occasionally, members might hold meetings over dinner at a restaurant to discuss new loan requests or to select a new hui dong.

The process is as informal as it is reliable. The default rate on such lending is near zero. "It's a code of honor," says Dong Tao, Hong Kong-based managing director and chief regional economist at Credit Suisse. "Everyone knows each other so they can't afford to default."

Another agent of underground lending is known as the yin bae, or bank carrier, a single financier who gathers funding for small-to-mid sized businesses. A veteran yin bae can raise tens of millions of dollars with a few phone calls. Frequently, cash-strapped businessmen will turn to a syndicate of yin bae to cover payrolls or capital investment costs. The system is so efficient that the local branches of China's state-run banks will often refer clients to the yin bae, particularly when the government imposes an embargo on new lending as a means to rein in inflation. "These people are professionals," says Xie Jian, a professor at Wenhzou University. "They are highly regarded and respected by the local bank-branch officers."

Underground loans command an efficiency premium of anywhere from double or even triple the official rate. (Under Chinese contract law, the central bank is obliged to insure private lenders against default so long as they don't charge borrowers more than four times what the state-run banks are demanding.) So vital is underground lending to the Chinese economy that the country's central bank regularly surveys curb-market borrowing rates. According the OECD, the People's Bank of China's office in Wenzhou, the epicenter of informal banking, indexes informal credit costs each month with an army of several hundred monitors. "They say they do it for their own information," says Margit Molnar, an OECD researcher who has authored several reports on China's gray-market banking sector. "That's how important underground lending is."