Chinese economy: Beijing’s war on the credit boom

Like many small businesses across China, Zheng Weijun’s freight company had struggled to obtain credit from the state-dominated banking system. But in 2018 the 12-lorry business discovered Fincera, a peer-to-peer platform in Hebei province that collected money from retail investors starved of returns and channelled it to borrowers, mainly small trucking and logistics companies.

“We qualified for a Rmb200,000 [$31,000] loan and used it to expand the business,” Zheng says, adding that Fincera charged his company 9 per cent interest annually. “The traditional financial system does not reach down to us.”

Just a year later, however, the credit dried up after Hebei police accused Fincera of “illegal fundraising” — something it denies. “The government shut it down and offers no alternative,” Zheng complains, adding that his company’s recent loan applications have been rejected by state banks. “How are we to judge whether a [P2P] platform is good or bad? We only care that Fincera was willing to offer us a loan.”

Fincera’s founder and chair, Li Yonghui, was detained by police in December 2019 and is awaiting trial. The platform’s operations — it had Rmb9bn under management — are now in limbo, with investors unable to get their money back and borrowers unsure of how to repay their loans.

A former Fincera employee, who asked not to be named, argues that “there were no issues” at a platform that was delivering credit to a neglected sector of the Chinese economy. “They completely shut down the business anyway,” he says. “Accounts and systems were frozen, no one could manage anything. The police just took control and asked borrowers to pay the money back, but they are not going to be able to devote much manpower to that.”

Fincera, its clients and investors are collateral damage in a wide-ranging crackdown on financial risk waged by President Xi Jinping and vice-premier Liu He, the Chinese Communist party’s most powerful financial official, for the past five years. While the US is pledging to “go big” as its economy comes out of the pandemic crisis, China’s leaders are focused on the threat of excessive risk-taking in the financial system.

The campaign initially focused on P2P platforms and other components of China’s once rampant shadow banking sector — the off-balance sheet activities that financial institutions used to funnel credit to borrowers, especially those in the private sector who found it difficult to borrow directly from banks. It has since been extended to internet finance and property.

Some analysts warn that in curbing the credit-fuelled excesses of the past decade, Xi and Liu risk an overcorrection that could stifle innovative areas of financial activity and, ultimately, economic growth. From 2016 to 2019, the average annual increase in China’s corporate bankruptcies exceeded 30 per cent.

“China achieved tremendous catch-up growth by allowing market forces to play a larger role and by changing the incentives driving individual and entrepreneurial behaviour,” says Diana Choyleva, chief economist at Enodo Economics in London. “Top-down party control has been a drawback, not an engine, for growth.”

Zhu Ning, deputy dean at the Shanghai Advanced Institute of Finance, argues that Liu’s approach is necessary to disabuse people of the notion that the government will bail out everyone from individual investors to large banks and bond issuers when their bets go awry.

“The attempt to deleverage and rid the financial system of prevalent government guarantees may induce undesirable consequences and market panic,” he says. “But it is more of a trade-off between short-term and long-term goals . . . China has to work hard on preventing potential risks from interrupting its growth trajectory and sustainability in the long run.”

‘Borrowed money must be repaid’

During Xi’s first term in power, Liu operated in the shadows as one of the president’s most trusted advisers. Yet, even before he became a vice-premier and was promoted to the Communist party’s politburo in March 2018, Liu wielded far more power over financial and economic policy than the country’s premier, Li Keqiang — who is nominally responsible for the economy. Liu’s expansive portfolio now stretches as far as trade negotiations with both the US and EU.

“It is necessary to establish good standards of behaviour, psychological guidance and supervision,” he said in May 2018, shortly after his promotion, “so that society understands borrowed money must be repaid, investment entails risk and those who do evil things will have to pay a price”.

The P2P industry was just one of Liu’s many targets after its meteoric growth — and the collapse of some platforms — raised concerns about the sector’s stability. In the four years to May 2018, outstanding P2P loans soared from just Rmb30.9bn to more than Rmb1tn, according to Wind, a Chinese data provider. By the end of 2019 that figure had more than halved, to Rmb492bn.

In addition to targeting P2P platforms such as Fincera, authorities ultimately reporting to Liu have ordered sweeping investigations into the shadow banking sector, overseas investments by some of the country’s largest private-sector conglomerates and large bond issuers responsible for a series of high-profile defaults late last year.

Most recently, Xi and Liu, who also heads the powerful Financial Stability and Development Committee that oversees the central bank and China’s banking and securities regulators, have made global headlines by training their sights on Jack Ma’s Ant Group, China’s largest fintech company.

On Monday, Xi chaired a high-profile meeting that increased the pressure on Ant and other internet platforms. According to state media, the party’s central finance and economics committee warned that “some platform companies are developing in non-standard ways that present risks . . . It is necessary to accelerate the improvement of laws governing platform economies in order to fill in gaps and loopholes in a timely fashion.”

The outcome of the dramatic crackdown on Ma’s empire and the fintech industry will be a defining moment for the party’s relationship with the private sector, especially as Xi prepares to begin an unprecedented third term in power in 2022.

Ant’s $37bn initial public offering, which would have been the world’s largest had it proceeded as scheduled last November, was scrapped just days after Liu’s financial stability committee warned that “with the rapid development of financial technology and innovation, it is necessary to strengthen supervision in order to effectively guard against risks”. Alibaba, Ma’s ecommerce group, is the subject of a parallel anti-monopoly investigation launched by China’s market regulator.

Not even the all-important property sector, a critical motor for the world’s second-largest economy, has been spared. In November, Guo Shuqing, head of the banking regulator and also the central bank’s top party official, said the real estate industry was the country’s biggest “grey rhino in terms of financial risks”, accounting for about 40 per cent of total bank lending. The pronouncement followed concerted efforts by Chinese regulators to enforce “red lines” aimed at curtailing developers’ leverage.

Chen Long at Plenum, a Beijing-based consultancy, says the real estate market is “the only major bright spot” in otherwise “mediocre” post-pandemic consumption, with property sales now on their strongest run in five years. But, adds Andrew Polk at the advisory group Trivium in Beijing, a reckoning is coming: “One consistently winning bet has been that if Guo calls out a problem, it gets addressed.”

Financial risk as ‘national security’

In the spring of 2016 an anonymous article by “an authoritative person” was published on the front page of the People’s Daily — the party’s flagship newspaper. It warned about the dangers of the country’s rising debt levels in part due to a Rmb4tn stimulus programme launched in the wake of the global financial crisis. The mysterious author was Liu. A year later, Xi officially designated financial risk as a matter of “national security”.

Such views help explain why the Chinese government’s fiscal and economic response to the coronavirus pandemic has been relatively restrained. Beijing did let overall debt levels climb and tolerated a bigger budget deficit last year. But even as economic output fell almost 7 per cent in the first quarter of 2020 — the first year-on-year decline in decades — it still shunned “helicopter money” largesse and other forms of financial support showered by other governments on their citizenry.

At the annual session of China’s parliament, which closed on March 11, the government also signalled its intention to rein in most of the support measures it authorised last year to help weather the pandemic.

“Last year the economy was driven primarily by the traditional levers of infrastructure and real estate investment, which hit record levels,” says Jeremy Stevens, chief China economist for Standard Bank. “Policymakers,…