Joe Zhang has impeccable timing. The former investment banker’s book about running a small Chinese microcredit firm, “Inside China’s Shadow Banking”, has hit shelves just as concerns about the country’s runaway credit boom are capturing global headlines. Yet despite the title, it’s China’s state-owned banking system that emerges as the tale’s dysfunctional villain.
Zhang’s story is part memoir, part diagnosis. It begins with his brief tenure as chief executive of Wansui Microcredit, a small lender in southern China making business loans with interest rates as high as 23 percent a year. In extensive and sometimes unnecessary detail, he describes the controlled chaos of an institution struggling to grow despite restrictive rules and unsympathetic regulators. In an attempt to build a more sustainable firm, Zhang deploys all the tools of Chinese business: personal connections, mutual backscratching, and endless dinners.
China’s pervasive corruption is never far from the surface. Shortly after arriving at Wansui, Zhang discovers that two senior managers have accepted stock options from a borrower in return for a cheap long-term loan. Later, a private equity investor tries to interest him in a business that will raise money by selling investment products to bank customers. Success is assured because the bank president’s cousin has been granted a secret stake in the business. Zhang professes himself shocked, and steers clear.
Along the way, Zhang provides a helpful taxonomy of China’s shadow banking industry - a phrase that is as widely used as it is little understood. It is a world full of misleading labels. Beyond its name, Wansui Microcredit has little in common with the lending schemes for Bangladeshi peasants made famous by Nobel laureate Muhammad Yunus. “Trust companies” sound reassuring, but actually resemble Wall Street investment firms, arranging high-risk loans for borrowers shut off from conventional bank credit. Perhaps the best euphemism of all is “wealth management products”, actually parcels of risky loans sold to bank customers on the unspoken assumption that the institution will pick up the tab if things go wrong.
Critics often point to China’s shadow banking boom as evidence of the shaky foundations of economic growth. Zhang, however, makes a compelling argument that real problem lies with China’s regulated banking industry. Official interest rates, which are tightly controlled, have fixed the cost of borrowing below the pace of inflation for decades. Loan volumes are controlled by crude quotas imposed by the central bank. As a result, access to credit is determined not by market forces, but by official decree or personal connections.
Those able to borrow, mostly big state-owned firms, have ample opportunity to make extensive and sometimes wasteful investments. Smaller companies are forced to seek out alternative sources of credit at much higher rates. Consumers who are tired of watching the real value of their savings dwindle in their bank accounts speculate on property or other risky investments. This system is not just inefficient; it’s also responsible for China’s rampant inequality.
When China’s interbank interest rates spiked in June, the central bank held back from a rapid, public intervention. That decision has been praised as a sign that the authorities are finally willing to rein in uncontrolled credit growth. Yet it can also be interpreted as a retrograde step that will reduce the flow of credit to those that do not enjoy official favour. Zhang concludes the only solution is to loosen restrictions on bank interest rates and let the market decide.
But he admits that doing so will be dangerous: “The major challenge for the economy and the banking industry in the next decade is how to abandon financial repression without causing havoc.”
Zhang claims to have written this book on his Blackberry in ten days, and it shows. Its structure is as chaotic as the world he describes. The text flits between personal anecdote, biographical detail and analytical observation. Terms that might confuse the uninformed reader are not always explained. Nevertheless, these dispatches from the wild lending frontier add colour to a topic that is often lacking details.
That, and Zhang’s excellent timing, makes it a valuable reference for anyone attempting to understand the causes, consequences and conclusion of China’s credit boom.