Domino effect: new debt crisis hits Zhejiang

(Ecns.cn) -- Private enterprises in east China's Zhejiang Province are up against another credit crisis caused by a prevalent reciprocal loan-guarantee system, reports China Economic Weekly magazine.

The crisis involves more than 100 companies, including some on the List of China's Top 500 Privately-Run Enterprises for 2012, whose financing based on reciprocal or joint guarantees has reached over 10 billion yuan (US$1.6 billion).

It has become all too common in Zhejiang for small businesses to team up and use reciprocal guarantees to meet stringent bank requirements in order to get loans. And although the mutual guarantee network can help them withstand the risk of default, it also increases the possibility of a domino effect caused by all the businesses being tied together.

Legacy debts have begun shaking the capital chain since a number of business leaders in Zhejiang fled their failing companies earlier this year. As other companies are forced to take up the slack, the disadvantage of reciprocal loan guarantees has since become exposed like a raw nerve.

Zou Xiaodong, an employee of a leading agricultural enterprise in the province, tells China Economic Weekly that his company is tethered to the debt problem by Hangzhou-based property developer Tianyu Construction Co.

My company has little to do with Tianyu Construction, but we are financially linked to it through a province-wide, reciprocal loan-guarantee network, as are many other companies from furniture makers to import-export traders, says Zou.

Tianyu Construction was investigated in January for borrowing from private lenders (three other companies came under investigation in March for similar reasons), which led to banks immediately calling in loans from all companies involved.

After Tianyu Construction went bankrupt the situation quickly deteriorated, which also affected Zou's company: About 99 percent of the company's loans are in the form of mutual guarantees, totaling some 495 million yuan (US$79.2 million), Zou says.

To prevent the credit crisis from spreading further, in the past six months Zou has tried desperately to finance 150 million yuan and 20 million yuan for bad loans generated by two other companies on direct reciprocal guarantees, says the magazine.

While the lending crisis snowballed into a scandal in July, over 600 debt-laden private enterprises in Hangzhou cosigned a petition appealing to the local government for help. However, the government's program did not stop bankers from tracking down companies linked to bankrupt enterprises and collecting their loans.

According to statistics released by the Zhejiang government, about 40 percent of the province's financing is realized through reciprocal or joint guarantees. The non-official estimation is closer to 70 percent.

As more and more enterprises come under threat, it is not only a credit crisis but also a crisis of confidence that is jeopardizing the fundamentals of the local market, observes China Economic Weekly.

The financial industry regulator attributes the problem to the reciprocal guarantee system and private enterprises themselves, while the enterprises point their fingers at the banks.

Some banks lied, saying they would extend credit after the previous debts were paid, but in reality the banks later rejected loan applications, said Zhou Dewen, chairman of the Wenzhou Small and Medium-sized Enterprises Development Association.

Zhou criticized the banks for frequent unexpected behavior, such as pulling back credit at the first sign of trouble, which has put enterprises in even greater difficulties.

The banks are responsible for the credit bubble, as many of them have blindly trusted loan guarantors while failing to properly examine and screen loan candidates, an analyst has said.