Like many small businesses across China, Zheng Weijun’s freight company struggled to get credit from the state-dominated banking system. But in 2018, with 12 trucks, the company discovered Fincera, a peer-to-peer platform in Hebei Province that raised money from hunger-hungry retail investors and channeled it to borrowers, mostly small transportation and logistics companies.
“We qualified for an Rmb200,000 [$31,000] loan and used it to expand the business, ”says Zheng, adding that Fincera charges his company 9 percent interest annually. “The traditional financial system does not reach us.”
However, just a year later, the credit faded after Hebei police accused Fincera of “illegal fundraising” – something they deny. “The government is shutting it down and offering no alternative,” Zheng complains, adding that his company’s recent loan applications have been rejected by state-owned banks. “How should we judge whether a [P2P] platform is good or bad? We only cared that Fincera was willing to offer us a loan. “
Fincera’s founder and chairman, Li Yonghui, was detained by police in December 2019 and is awaiting trial. The platform’s operations – it had Rmb9 billion 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, says that “there were no problems” on a platform that provided credit to a neglected sector of the Chinese economy. “They closed the business completely anyway,” he says. “Accounts and systems were frozen, no one could manage anything. The police just took control and asked borrowers to pay back the money, but they won’t be able to spend much manpower on that. “
Fincera, its clients and investors have become collateral damage in a broad approach to financial risks that President Xi Jinping and Deputy Prime Minister Liu He, the Chinese Communist Party’s most powerful financial officer, have pursued over the past five years. While the US pledges to “get big” as its economy emerges from the pandemic crisis, Chinese 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-thriving shadow banking sector – the off-balance-sheet activities that financial institutions used to route credit to borrowers, especially those in the private sector who found it difficult to get direct from banks. to lend. It has since expanded into internet finance and real estate.
Some analysts warn that in curbing the credit excesses of the past decade, Xi and Liu risk an over-correction that could stifle innovative areas of financial activity and, ultimately, economic growth. From 2016 to 2019, the average annual increase in company bankruptcy in China was more than 30 percent.
“China has seen tremendous catch-up growth by empowering market forces and changing the incentives for individual and entrepreneurial behavior,” said Diana Choyleva, chief economist at Enodo Economics in London. “Top-down party control was a disadvantage, not an engine, for growth.”
Zhu Ning, deputy dean at the Shanghai Advanced Institute of Finance, argues that Liu’s approach is necessary to dissuade people from the idea that the government will save everyone from individual investors to major banks and bond issuers if their bets go wrong.
“The attempt to deleverage and rid the financial system of prevailing government guarantees could have undesirable consequences and market panic,” he said. “But it’s more of a trade-off between short and long-term goals. China needs to work hard to avoid potential risks from interrupting its growth trajectory and long-term sustainability.” “
“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. But even before becoming Deputy Prime Minister and being promoted to the Communist Party’s politburo in March 2018, Liu had far more power over financial and economic policies than the country’s prime minister, Li Keqiang – who is nominally responsible for the economy. . Liu’s extensive portfolio now extends to trade negotiations with both the US and the EU.
“It is necessary to establish good standards of behavior, psychological counseling and supervision,” he said in May 2018, shortly after his promotion, “so that society understands that borrowed money must be paid back, investment carries risk and those who do bad things. to pay a price ”.
The P2P industry was just one of Liu’s many goals after the rapid growth – and the collapse of some platforms – raised concerns about the stability of the sector. In the four years to May 2018, outstanding P2P loans increased from just Rmb30.9 billion to more than Rmb1tn according to Wind, a Chinese data provider. By the end of 2019, that figure had more than halved to Rmb492 billion.
In addition to targeting P2P platforms such as Fincera, authorities ultimately reporting to Liu have commissioned sweeping investigations into the shadow banking sector, overseas investments by some of the largest private sector conglomerates and major bond issuers responsible for a range of high profile defaults. late last year.
Most recently, Xi and Liu, who also lead the powerful Financial Stability and Development Committee that oversees the central bank and China’s banking and securities regulators, made global headlines by focusing their gaze 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 committee on finance and economics warned that “some platform companies are developing in non-standard ways that involve risks. It is necessary to accelerate the improvement of laws governing platform economies to close gaps and loopholes. to be completed in time by law. “
The result of the dramatic crackdown on Ma’s empire and the fintech industry will mark a defining moment in the party’s relationship with the private sector, especially as Xi prepares to begin an unprecedented third term in power in 2022.
Ant’s $ 37 billion initial public offering, which would have been the largest in the world had it gone as planned last November, was dropped just days after Liu’s financial stability committee warned that “with the rapid development of financial technology and innovation, it is necessary to strengthen surveillance to effectively guard against risks. ”Alibaba, Ma’s e-commerce group, is the subject of a parallel anti-monopoly investigation launched by the Chinese market regulator.
Even the all-important real estate sector, a vital driver of the world’s second-largest economy, has not been spared. In November, Guo Shuqing, head of the bank regulator and also the central bank’s top party official, said the real estate sector is the country’s largest “ gray rhinoceros in terms of financial risk, ” accounting for about 40 percent of total bank loans. The ruling followed concerted efforts by Chinese regulators to enforce ‘red lines’ to curtail developer leverage.
Chen Long of Plenum, a Beijing-based consultancy, says the real estate market is “the only big bright spot” in an otherwise “mediocre” post-pandemic consumption, with real estate sales now on their strongest run in five years. But, adds Andrew Polk of the Beijing advisory group Trivium, a bill is coming: “A consistently winning bet is that if Guo raises a problem, it will be 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 People’s Daily, the party’s flagship newspaper. It warned of the dangers of the country’s rising debt levels, due in part to an Rmb4tn stimulus program launched in the wake of the global financial crisis. The mysterious author was Liu. A year later, Xi officially labeled 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 increased its total debt and tolerated a larger budget deficit last year. But even as economic output fell nearly 7 percent in the first quarter of 2020 – the first year-on-year decline in decades – it still eschewed “ helicopter money ” and other forms of financial aid poured over to their citizens by other governments.
At the annual session of the Chinese parliament, which closed on March 11, the government also announced its intention to curtail most of the aid measures it had approved last year to help deal with the pandemic.
“Last year, the economy was mainly driven by the traditional levers of infrastructure and real estate investment, which hit record levels,” said Jeremy Stevens, China chief economist at Standard Bank. “Policymakers, who did not want to go down this path, felt they had no choice.
[They] knows that this will harm tomorrow’s growth, exacerbate structural imbalances in the economy and exacerbate over-reliance on credit and infrastructure, ”he adds. Moreover, China already had a stressed financial system – a reality that was exacerbated [aggressive] bank patience and lending last year. “
A prominent Chinese financier, who advises the government on policy issues, says he avoided Ant’s IPO because of this broader policy background. “That was very clear to me a year ago [tougher fintech] regulation was at hand – capital requirements, deposit withdrawal permits and a much lower interest rate cap for online lenders, ”says the financier.
“Five years ago everyone was talking about shadow banking,” he adds. Who’s talking about shadow banking now? Thousands of P2P lenders have disappeared. It was a long process lasting several years. This has not happened overnight. ”
When regulators started attacking the shadow banking sector in 2017, the amount outstanding in asset management products was estimated at Rmb29tn or 40 percent of gross domestic product, according to official data. At the end of 2020, it was estimated to be worth Rmb25.9 trillion. But the crackdown made it even more difficult for smaller private sector companies, such as Zheng’s transportation company, to access much-needed credit. The Chinese private sector accounts for 80 percent of China’s urban employment and 60 percent of its economic output.
“The pressure on P2P lenders and the shadow banking sector is limiting lending to the private sector,” said Eswar Prasad of Cornell University. “China,” he adds, “appears to be going down the path of giving innovators plenty of leeway and then cracking down when they become too powerful or the risks become too great to ignore.”
Mom is risking everything
Many believe that Jack Ma sealed his own fate with a speech on Oct. 24 – a fortnight before Ant’s IPO was abruptly canceled – when he appeared to criticize Xi and Liu’s orthodoxy on financial risk as a penny-wise, pound-silly strategy. “Very often, trying to minimize the risk to zero is the greatest risk in itself,” said the entrepreneur.
The first sign that Ant’s IPO could be in trouble came on October 31. And it came through Liu. Its Committee on Financial Stability and Development stated that “with the rapid development of financial technology and innovation, the relationship between development, stability and security must be properly addressed”. Within days, top regulators were enacting strict new rules that would curb Ant’s profitability, calling Ma and senior Ant executives to emergency meetings, and canceling Ant’s IPO towards Xi.
The committee added that “regulators should do their jobs conscientiously and treat similar companies and institutions equally” – an acknowledgment of longstanding complaints from China’s largest state-owned banks that Ant and other private sector fintech competitors were unfairly benefiting from a supervisory regime that keeps state banks to higher regulatory standards.
Xi has also made it clear that his vision is a future where ever “stronger, bigger and better” state-owned enterprises continue to dominate the dominating heights of the world’s second-largest economy.
“Security and development are now seen as inseparable and security trumps all other considerations,” said Choyleva. Xi focused more on identifying and preventing security challenges than on [waiting to] treat them as soon as they arise. ”
Continuation of the Crusade
To its proponents, Fincera’s fate exemplifies the excesses of Liu’s war on risk, especially when vague signals from Beijing – in this case about the dangers of P2P lending platforms – are pushed to the limit by local officials.
Fincera was the largest P2P platform in central Hebei province, an industrial powerhouse with a population of 75 million. In July 2018, Hebei officials ordered by Beijing to investigate the sector said they had not found any irregularities on the platform.
“That made us feel very comfortable,” says a retail investor whose family at the time invested nearly Rmb10m in Fincera. The government said “calmly, Fincera is legal.”
A year later, Hebei officials resumed investigations into Fincera and other P2P companies in the province as part of Liu’s broader crackdown on the industry. “Fincera has been subject to numerous investigations led by the Hebei Financial Bureau,” said Li, the company’s chairman, in a social media post in July 2019. He added that his company “complies with all centrally established regulations” and is “operationally sound”. .
Five months later, Li took his daily walk before sunrise and never returned. On the same day, busloads of police arrived at Fincera’s offices in Hebei and Beijing.
“It was actually all of my family’s savings,” says the investor, who asked not to be identified and now cannot get her money back. She fears she will have to sell her apartment: “We have become economic refugees.”
However, such pain will not stop Liu and his lieutenants from continuing their crusade.
“We will continue to see a continued focus on risk,” said Prof. Prasad. “Even if they manage to control one aspect of leverage in the economy, it pops up elsewhere. It’s a never-ending battle. “
Additional reporting by Xinning Liu, Sherry Fei Ju and Sun Yu in Beijing