CGCs: China’s murky credit channels

Elliot Wilson
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Ostensibly designed as middlemen to safely channel bank credit to the neglected private sector, credit-guarantee companies have not been content with this fee-earning business.

Wei Ding perches himself on a high stool in the main bar of Beijing’s Kerry Hotel and chews his lip. A leading corporate banker at China Merchants Bank (CMB), one of the country’s best-run lenders, Wei is here to discuss credit-guarantee companies (CGCs), a burgeoning division of the country’s controversial shadow-banking industry.

He’s nervous, and for good reason. China’s CGCs have had an appalling couple of years, lurching from one humiliation to the next. His job puts him in daily contact with dozens of guarantee firms, all beseeching the banker to lend credit to their clients, a cross-section of China’s corporate economy, from small private enterprises to big state-owned enterprises (SOEs). "They ring [me] in the morning. They ring me at lunch. They ring me in the evening. They ring me on the toilet," he sighs wearily.

Mostly, these are the banking version of nuisance calls: guarantee firms ringing up to chance their arms. "They call to tell me that some company wants to borrow Rmb100 million ($16 million). I ask: ‘What is the name of the company?’ They can’t say. ‘How big is it?’ They can’t say. ‘What do they do?’ They can’t say – but they still expect [to get the loan]. They are crazy."

Nor is this far from the norm. CGCs barely existed five years ago. Now they are an integral part of China’s shadow or grey financial sector, an industry that encompasses everything from loan sharks and pawn shops to trust companies and pure underground banks, the latter congregating around the coastal city of Wenzhou. Around half of all new credit injected into the economy is provided by non-banks or through such operations as CGCs, up from 10% a decade ago.

In many ways, CGCs are the least understood and the most maligned features of this murky industry. Barely a handful existed before the financial crisis. Precise numbers are hard to come by: the industry is patchily regulated, often supervised at the provincial level. But a reasonable estimate, reached by talking to dozens of people with knowledge of the sector, places the nationwide tally at between 25,000 and 30,000.

Most lack size or scale. A July 2012 report on the shadow-banking industry by Bank of America Merrill Lynch, quoting statistics from China’s Ministry of Industry and Information Technology, reckoned that just 29 CGCs with credit-guarantee licences from the China Banking Regulatory Commission (CBRC) boasted more than Rmb1 billion in registered capital as of end-2010. More than 70% of the 6,030 CGCs registered then were too small to guarantee loans valued at more than Rmb10 million.

What is so surprising is how little is known about a motley collection of companies reckoned to control assets worth between Rmb1 trillion and Rmb2 trillion.

Only rarely, do these monsters surface, offering glimpses of their misshapen hides. The last appearance involved the collapse of Zhongdan Investment Credit Guarantee, one of Beijing’s most prominent CGCs, which imploded in April 2012 with debts of around Rmb3.3 billion. Zhongdan’s silent failure – its bankruptcy is widely known in banking circles, but has never been admitted publicly – exposed 20 banks to substantial losses, say individuals involved with the issue.

The biggest loser was Bank of Beijing (BoB), the largest city commercial lender in the Chinese capital, whose leading shareholders include the Dutch financial services company ING Group, which was exposed to losses amounting to Rmb550 million.

BoB was particularly endangered: not only was it the bank most heavily exposed to financial losses following Zhongdan’s collapse, it was also by far the smallest. The second and third most heavily exposed lenders, Agricultural Bank of China and China Minsheng Bank (CMBC – one of only two privately run Chinese lenders), were far more easily able to absorb substantial losses. "This raises a further issue," notes a Beijing-based shadow-banking expert. "When a credit-guarantee firm collapses, or there is a failure in the shadow-banking industry in general, it tends to be the smaller banks that struggle to meet their liabilities. So you find that the institutions least capable of taking big balance-sheet hits are also those most likely to be exposed to CGCs in general."

Zhongdan’s collapse was unusual for two reasons: first, its sheer scale; second, that its failure was made public at all, thanks largely to the trailblazing efforts of Chinese media outlet Caixin. Moreover, the Zhongdan case shone a light on an industry hitherto almost wholly invisible to outsiders, yet which has, in a few short years, become an indispensable lubricant to China’s financial economy.

CGCs are both very simple and incredibly complex. In their basic form, and certainly in the early days of the credit-guarantee industry (roughly late 2008 to early 2011), their job was to help small and medium-sized enterprises access credit. SMEs struggled during this period, as China’s state banks, swollen by a glut of stimulus cash, channelled loans to favoured SOEs.