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Private lending needs to be better regulated

By Wang Yue and Shang Yiying: 0 Comment(s)Print E-mail Shanghai Daily, March 9, 2012

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[By Zhou Tao/Shanghai Daily]

Only weeks after a court upheld the death sentence of Wu Ying, a once hugely wealthy businesswoman who was convicted of fund raising fraud, another entrepreneur also from Zhejiang Province has been detained on suspicion of a similar crime.

Following the detention of education tycoon Dong Shunsheng on February 3 in the east China city of Wenzhou, an accounting firm, which is a third party in the case, said Dong's company owed a whopping 4.5 billion yuan (US$714 million) to more than 7,000 private creditors.

The company itself had declared earlier that it owed 2.2 billion yuan to about 1,000 lenders.

Liren Education Group announced on October 31 that it would stop repaying creditors and start restructuring its assets.

The group based in Wenzhou's Taishun owns 36 schools and companies across the country. Its subsidiaries operate in several sectors including education, real estate and mining.

Everyone in the county of Taishun viewed Dong as a star who had greatly contributed to promoting local education, said an official with the county's education bureau.

Dong started his business in 1998 by renting a ceramics factory and turning it into a private high school.

The business later developed into a chain that has schools from kindergartens to high schools, all under the name "Yu Cai," which means "create talents."

Ponzi scheme

Dong invested massively in his schools, making them among the best in Taishun. Yucai schools have more than 4,700 students and 1,000 faculty members.

Much of the investment came from private financing.

Though the schools' tuition fees were much higher than those of public schools, the company still operated in the red in the first few years.

To cover the losses, Dong came up with other ways to generate profit.

In 2003, he established the Liren Group and began expanding into the mining and real estate sectors, which again required enormous investment.

But the man was never late in repaying his loans, and consequently locals referred to him as the "God of Credibility."

People with extra cash rushed to lend money to Dong.

Others even borrowed money from family and friends, expecting to make a fortune by investing in Liren.

Paying high interest for years led to Liren's downfall, said Zhang Hongguo, Taishun's Party chief.

Auditors said the company had paid 3 to 3.5 billion yuan in interest over the past 10 years.

When Liren's real businesses could no longer repay creditors, the whole thing turned into a Ponzi scheme - the company started offering even higher interest to attract more money and then use investors' money to pay returns to earlier creditors.

Tempted by high returns, people took out bank loans and some even mortgaged their homes to invest in Liren.

Many of Liren's creditors are civil servants and some even work for the judicial departments, which may explain why those government organs earlier had turned a blind eye to the extensive fund raising.

Some creditors had learned about Liren's alarming situation but still wanted to gamble.

"Many knew that the profit was not enough to pay off the interest with an annual interest rate up to 60 percent. But who would have thought that this would have ended so quickly?" said a creditor who requested anonymity.

Dong's fall from grace again raises concerns over the risks in private financing, which is booming in China, especially in Zhejiang where private businesses have become a pillar of the prosperous local economy, accounting for about 70 percent of the region's gross domestic product and providing 90 percent of its jobs.

However, most private companies have problems getting bank loans as banks prefer lending to big state-owned enterprises.

"If Liren could get loans from banks, this never would have happened. Who wants to pay high interest?" said Yan Hanrong, an entrepreneur in Taishun.

It has been more than 30 years since China started implementing market economic policies, but the country's financial market is yet to be fully opened up.

Money problem

Last year, a government survey found that more than half of the 2,835 investigated companies in Zhejiang have sought financial help from private creditors. About 9 percent of the companies said they use high-interest private loans "all the time."

During last year's credit crunch, about 100 managers or leaders of private companies in Wenzhou were reported to have disappeared, committed suicide or declared bankruptcy - defaulting on debts of about 10 billion yuan by the end of October.

Professor Fu Yunsheng with the research institute of economics under the Zhejiang Academy of Social Sciences suggests that private financing should be brought under unified regulation.

He recommends that a standardized information disclosure system be established for the capital sources, investment and operation of private fund raisers and that efforts should be made to improve risk awareness for individual investors.

The authors are Xinhua writers.