In China, a Debtor Fights to Stay Afloat

Pharmacist Zhong Maojin runs afoul of the informal loan network in the city of Wenzhou

By Shai Oster and Fan Wenxin

Hours after a creditor and his gang of tattooed thugs had hustled Zhong Maojin into a coffee shop in Wenzhou, he still refused to yield to their demands. They wanted to take over one of the pharmacies in a chain he’d built by borrowing from informal lenders. “If you like, you can cut off one of my fingers instead,” Zhong, 42, says he told them.

Giving up the store would have made it impossible to pay back 130 other creditors, Zhong says. Unable to borrow at low rates from state banks, which make few loans to private companies, he’d borrowed 30 million yuan ($4.7 million) from private—or informal—lenders and loan sharks at rates as high as 7 percent a month.

Wenzhou’s 400,000 or so businesses are facing hardship as black-market interest rates jump and state-owned banks tighten credit to rein in inflation. According to Zhou Dewen, head of a small business association, 90 bosses in situations similar to Zhong’s have fled Wenzhou since April and two have killed themselves. After an October visit to the city by Premier Wen Jiabao, national and local leaders said they would offer small companies easier access to bank loans, put a cap on informal lending rates, and crack down on loan sharks. Zhong is still in trouble. “I am under huge pressure,” he says, sitting in a warehouse with fast-depleting stocks of medicine.

Wenzhou was the first city in China to widely embrace private enterprise in the early 1980s. As businesses tapped families and neighbors for loans, the local authorities took a lenient view of this private lending, according to Huang Yasheng, an associate professor at the Massachusetts Institute of Technology’s Sloan School of Management. Zhong relied on such lenders to build Blue Sky Pharmacy into a chain of 27 shops in three years. Zhong, a doctor from a mountain village, first borrowed to pay the medical bills for his wife, who died at 23 of liver disease. After he remarried, to a woman with debts of her own from running a money-lending business, he opened a pharmacy in Wenzhou. Rebuffed by the banks, he turned to elderly natives of his rural Taishun County who had migrated to a neighborhood of concrete houses near the airport on the outskirts of Wenzhou.

These neighbors often mortgaged their homes to extend Zhong more credit as he expanded. It wasn’t just Zhong. They turned money lending into a cottage industry, according to interviews with six of them. Taking out bank loans at 1 percent a month, many have lent out their cash for 2 percent or more a month. They pocket the difference to supplement meager income from odd jobs.

Sitting on a small stool, gray-haired Jin Xiaoyu fills a wooden box with the electrical clamps she makes to earn 10 yuan a day. She has trouble seeing; her left eye is the milky-white color of a cataract. She lent Zhong 50,000 yuan from her savings and charges 1,000 yuan a month in interest. “I worry that I cannot get the money back,” she says. “I hope the government will help him out.” One of Jin Xiaoyu’s neighbors, Wu Suihua, borrowed from the bank against her five-story home to lend to Zhong.

One-third to half the money used the private lending network originally comes from banks, says Lu Ting, an economist with Bank of America’s brokerage unit. Since some of Zhong’s lenders posted their homes as collateral to borrow, his credit problems may ultimately cause trouble for the banks.

By summer 2010 the government had tightened credit, and some of the lenders who had moved from Zhong’s rural county could not get new loans from the banks. Zhong still needed cash to keep paying his suppliers, cover the rent, and make payroll. Scanning the newspaper one day last year, he saw an ad for loans without collateral. He dialed the number and arranged to borrow 600,000 yuan for one month from a gaolidai, or loan shark. He borrowed again and started paying just the interest, rolling over the principal. Informal lenders demand annual interest of 20 percent to 40 percent, many times the official lending rate of 6.6 percent, according to UBS economist Wang Tao.