I’ve written before about how, as China’s monetary policy tightened, credit from the formal banking system has become difficult for some companies, particularly for the small to medium sized businesses. As a result, these companies are increasingly relying on underground credit, which includes things like loan sharks and pawnshops. These underground banking system usually charge very high interest rates (in the order of tens of percentage points per annum), which are quite unsustainable. With high interest rates and potentially questionable credit quality, I have been expecting problems.

Recently they started to surface, and some of these business owners fled. In a previous post, I described the situation in Wenzhou, where even selling off real estate wasn’t enough to help some business owners financial situation. Now, more problems are surfacing in Wenzhou. Two recent stories tell the tale.

A few days ago, the Shanghai Daily ran with a story with the title “Subprime crisis sweeps Wenzhou as bankrupt bosses flee”:

The east China city of Wenzhou is battling its own subprime crisis after seven local business owners fled recently, leaving thousands of employees in a state of shock and enormous unpaid loans in hundreds of millions of yuan. Most of the runaway bosses who have disappeared since September 12 are in the manufacturing industry, according to today’s National Business Daily. Each of them had borrowed hundreds of millions of yuan from banks and private creditors.

Today, Sina ran a story about another nine business owners that fled their debts on 22 September. The story also highlighted that bank deposits are shrinking as depositors are attracted by the higher rates of interests that the underground banking system is able to offer.

Businesses in Wenzhou are facing unprecedented challenges, with rising costs and slowing economic activity impacting their cash flow cycle. Waves of bankruptcies are happening, and business owners are running away.

With unbearably high interest rates charged on borrowers and questionable credit quality, the development is not reassuring.