Official: China sends more than 1,400 to prison in crackdown on underground lending

BEIJING, China – Chinese authorities have sentenced more than 1,400 people to prison terms of at least five years for involvement in underground lending in a crackdown on a financing practice widely used by China’s entrepreneurs, a police official said Friday.

The 1,449 people imprisoned were among a total of 4,170 people convicted since 2011 of violating rules on loans outside the state-run banking system, said Du Jinfu, a Public Security Ministry official in charge of a task force on underground lending. He said the rest received lesser penalties.

Entrepreneurs who generate China’s new jobs and wealth are largely shut out of lending by government banks and rely heavily on informal lending by individuals. Loans are arranged by middlemen who are paid a fee and borrowers pay interest of 70 per cent a year or more.

People netted in the crackdown were convicted of violations including public advertising to find lenders and promising excessively high rates of return, Du said at a news conference. He gave no details.

Legal experts say loans between individuals are legal and the government has failed to make clear what lenders and borrowers are allowed to do.

“The distinction between illegal fundraising and private lending still remains unclear,” said the Dui Hua Foundation, a San Francisco-based group that researches China’s justice system, in a report in February.

The crackdown threatens to crimp credit to entrepreneurs who the World Bank and other advisers say the government should be encouraging in order to keep China’s economic growth strong.

Communist leaders have promised more bank lending to the private sector but entrepreneurs say they still have trouble getting loans.

Du, the police official, did not explain whether the people punished in the crackdown were the final borrowers or middlemen who arranged loans for a fee, a common practice.

In a high-profile case, an entrepreneur from the southeastern city of Wenzhou, Wu Ying, was sentenced to death last year for “illegal fundraising” though details were not disclosed. The 31-year-old woman, whose business success had been celebrated by state media, was convicted of improperly raising 770 million yuan ($120 million) from investors in 2005-07.

China’s supreme court overturned Wu’s death sentence following an outcry on the Internet over the severity of the penalty. She was re-sentenced to death with a two-year reprieve, which usually is commuted to a long prison term.

According to an explanation on the supreme court website, charges of “illegal fundraising” can be applied to an individual who receives more than 200,000 yuan ($32,000) of informal loans or causes losses to lenders of 100,000 yuan ($16,000). Enterprises can face charges if they receive 1 million yuan ($160,000) or causes losses of 2.5 million yuan ($400,000).

The underground credit market is estimated by China’s central bank and private sector analysts at 2 to 4 trillion yuan ($325 to $650 billion), or as much as 7 per cent of total lending. In some areas, informal lending exceeds that of official banks.

In 2011, only 19 per cent of bank lending went to small businesses, while total loans fell 6 per cent from 2010, according to the official Xinhua News Agency.

Many households provide money for private lending in an effort to get a better return than the low deposit rates paid by Chinese banks, which effectively force depositors to subsidize low-interest loans to state industry.

Protests erupted in 2011 and early 2012 in cities and towns throughout central China and along the southeast coast, areas with large concentrations of small private businesses, after the downturn in global trade triggered a wave of defaults. Schoolteachers, retirees and others who had lent to entrepreneurs demanded authorities get back their money.

Regulators also worried banks and state companies had gotten involved in underground lending, exposing the official financial system to unreported risks.

The Cabinet announced a pilot effort last year in Wenzhou to test more closely regulated private lending.

“The greatest significance of Wu Ying’s case is the way it has sped up the pace of reform of private financing,” said the Dui Hua Foundation. “There will probably be many more ‘Wu Yings’ in the future, but no one hopes to see any more ‘Wu Ying cases.’ “