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Usury in China

In the Blood Red

A recent tragedy has put loan sharks in the public eye. Sympathy or anger are not the solutions to avoiding further incidents. Legal process and exit mechanisms are

By NewsChina Updated Jul.1

On April 14, 2016, using a fruit knife, a 22-year-old man stabbed thugs who had used violence when calling in debts from his mother who had borrowed from a local loan shark. The incident happened in an office at the factory his mother owned in Guanxian, an underdeveloped county in eastern Shandong Province, and when the police arrived, the son was still in the vicinity. One of the 11 gangsters, Du Zhihao, later died in the hospital and three others were injured. On February 17, 2017, the young man, Yu Huan, was sentenced to life imprisonment for intentional injury and ordered to pay about US$12,500 in compensation to the two severely injured men and to the relatives of the dead.  

A request to have the case appealed was lodged on March 24, 2017, then on March 25, a report by Southern Weekly, a newspaper, detailing the abuse the mother had faced triggered public outrage over the verdict and was reposted and shared widely by portal websites and on social media. Many online comments criticized the sentencing for going against humane values. Some legal experts also publicly defended the young man’s behavior. They believed that Yu Huan was innocent or at least deserved much more merciful punishment as he was defending the lives and dignity of his mother and himself in an emergency. Some commentators even hailed him for having the guts to do what a son should do for his mother in this situation.  

Under such public pressure, the Supreme People’s Procuratorate of China declared on March 26 that its procurators were being sent to Shandong to review all the evidence of the case and see whether Yu Huan had committed “justifiable homicide,” “excessive defense” or committed “intentional injury.” Any possible police misconduct would also be subject to this investigation. 
The same day the provincial high court vowed to fairly and openly hear the appeal filed by both Yu Huan and the family of Du Zhihao, who was the father of four children.  

It is up to the new investigations to find out what really happened in that office at that time and who should be held responsible. The only thing that is known for sure so far is that usury that had haunted the mother and her company long before led to horror and tragedy. While public opinion has shown a great deal of sympathy toward the young man’s acts, it is much more divided when it comes to his mother’s involvement in borrowing illegally.  

Violent high-interest loans, or loan sharking, constitutes a crime across much of the world. However, the role of such lending itself in an economy is a much more controversial issue than simply the stigma attached to the individual lenders and borrowers involved. Usury in China is nothing new. The recent Shandong tragedy has made it more controversial than ever, due to China’s current broader economic context. The debates on whether it is a lifeline or a trap for those in financial difficulties are similar to those that have been held in the US. Besides, the brutality and spread of the business in China has been attributed to the absence of crucial legal protections. Experts hope that the bloody story will force a step toward fixing urgent systematic and legal problems in China’s economy, which could also make usury at least less rampant and violent than it is.  

Snowballing Debt  

To date, Yu Huan’s first verdict, media reports and his mother’s letter of petition for mercy for her son have given conflicting information about how much she owed to the lender behind the violence. But all these sources have confirmed that in 2014 and 2015 she borrowed more than US$160,000 at a monthly interest rate of 10 percent.  

The annual interest rate that this resulted in has been reported differently by the verdict, Su’s petition and the Southern Weekly, but every calculation puts it much higher than the legal cap of 36 percent for private lending in China. Rates up to 24 percent are fully legal, while rates between 25 percent to 36 percent are subject to judges’ discretion. In the US, high interest rate small loans, typically payday lending, are governed on a state-by-state basis, ranging from legal, restricted or prohibited, subject to state law. 36 percent is the recently introduced US federal cap imposed on consumer financing products for those on active military duty, and they cannot use payday lending services.  

Besides the brutality of Yu Huan’s case, the broader economic context has been enough to trouble the public. Unlike in the US or the UK where high-interest small loans today are typically granted by licensed institutions to individual consumers in need of a few hundred bucks, in China they have often been made by private lenders to small and medium-sized private entrepreneurs like Yu’s mother, Su Yinxia. They have relied on much larger loans since China’s economic take-off in 1980s when there were barely any commercial banks. This source of funding has remained important for their survival and expansion over the past few decades when banks have preferred lending to State-owned or large-scale enterprises. When the growth rate is high, the going is good. Once defaults rise in an economic downturn, so do disputes and violence on such loans.  
According to the publicly available verdicts of cases from various local courts in Shandong and Hebei provinces, since 2015 Su Yinxia and her company lost a number of legal disputes as borrowers or guarantors involving more than US$6 million in debts to private lenders, banks and business partners. Her company makes and sells steel products, and began to struggle in 2014 when the sector was shattered in the economic downturn, revealing overcapacity in the steel industry.  

Su’s story is not new or rare. In 2011, when China’s growth began to slow, the public and top policy makers were shocked by a number of cases in once-prosperous Wenzhou, Zhejiang Province, where heavily indebted entrepreneurs of small and medium enterprises (SME) fled, were kidnapped or even committed suicide. Various measures have been taken to provide mainstream access to capital for SMEs so that they do not have to resort to underground lenders. However, the efforts seem not to have worked well. SMEs have benefited from looser monetary policy much less than State-owned or large enterprises, and have also been hit much harder once monetary policy is tightened. They are also much more vulnerable to the boom and bust cycle in which loan sharking plays a role. Similar cases to those in Wenzhou broke out from time to time in different cities grappling with depression.  

Private investment in the real economy (the manufacturing, engineering or delivery of tangible goods as compared to some online services or property speculation), where Su was operating, has been down for months, a major barrier towards a real growth rebound of the country’s economy from a seven-year slowdown. By contrast, mega cities have been binging on the real estate market, and banks have been enjoying higher profitability than the real economy. Financial News, a paper under China’s central bank, stressed in an editorial on Su’s case on March 30 that a better structured financing market is the key to avoiding similar tragedies happening again. The problem is that such an outcry has been ongoing for years already.  

In addition, the credit crunch has recently spread to large, private companies. Right before and after Yu Huan’s case, several giants in their respective sectors, ranging from dairy, food and textiles to metals, new energy and real estate, had their massive debts exposed. They faced share price slumps or bankruptcy. Part of their debt was made up of massive high-interest private lending.  

In this context, Su’s case has immediately fueled concerns over the crucial challenges for China’s economy, including the difficulties facing the manufacturing sector, private investment in the real economy and the country’s corporate leverage which is believed to be the highest in the world by any standard.  

The factory where Yu Huan stabbed thugs who had used violence when calling in debts

Boon or Trap 

The overwhelming call so far is to crack down or even ban money lending. But a few Chinese economists have gone as far as to hail money lending as a market blessing for desperate private companies which are turned down by banks and relatives. A more moderate argument which has thus gained more support calls for deregulation of the lending market. “Many commentators [on Yu Huan’s case] have failed to see the lack of rule of law, damaged social morality and distorted financial system. Their blaming of money lending as the culprit for the tragedy [of Yu Huan] is misplaced,” says Wang Jun, director of the CEIBS-World Bank China Centre for Inclusive Finance in his notes for the republishing of his 2005 The Chinese Banker article on chang-talk, a public WeChat account run by former Caixin magazine editor Chang Hongxiao, on March 31. He thinks official caps on lending rates to curb excessive interest just starve small businesses and the poor from accessing loans, rather than protecting them from usury. It is unreasonable, he argues, to impose an annual rate, as such high interest rate loans for small businesses are mostly for the short term and thus much more affordable than if calculated with annualized rates. He added that small businesses normally generate much higher returns than bigger ones to cover the high cost of borrowing.  

In addition, the high rates imposed by licensed lenders have also raised the question of what is fair application of the law. In 2015, a local court in Chengdu, Sichuan Province, did not support a bank’s claim for charging much higher than 24 percent interest on an overdue credit card repayment. The rule stressed equal treatment of lending contracts either by banks or by private lending. However, rules like this remain more an exception than the norm, and banks have not changed their policies. Recently, a host of a China Central Television law program sued a bank for the high fees it imposed on his late credit card repayment. 
A more diversified mainstream supply of loans may help reduce usury, as has long been advocated by economists, including Wang, as well as policy makers, but the demand for money lending will always be there, an insider of the small loans industry, who asked for anonymity, told NewsChina. He said there are always groups in any society who desperately need money in an emergency but are denied access to any mainstream financing. He guessed that Su was out of the reach of a much cheaper, licensed small loan company, either because there was no such provider in her underdeveloped county, or because her credit was rated as too poor for a small loan company to be willing to lend to her. 

The latter possibility means that victims like Su Yinxia do not always earn public sympathy. Su is criticized by many online commentators for irrational borrowing which ruined her son’s life. Her creditworthiness looked dubious due to her massive debts before and after this loan and her failure to comply with prior court rulings on debt repayment before the tragedy. Debt evasion faces growing social resentment in China today. Su was on the blacklist of dishonest debtors set up by the Supreme People’s Court of China in 2013 to address rampant debt evasion. Debtors on this list are restricted from some activities. For example, they cannot buy high speed rail tickets.  
Another reason for the lack of sympathy to borrowers is the recent exposure of some cases in which young college girls used nude photos of themselves to borrow at online peer-to-peer (P2P) lending platforms. They used the money to buy things such as electronics. These cases were dubbed by media as “naked IOUs.” On April 10, the China Banking Regulatory Commission banned P2P services to college students under 18 years old.  

There is ongoing controversy over whether deregulation really reduces high-interest lending. Research in the US has already shown that payday lending boomed after the financial deregulation of the 1990s and raced to the high end of rates where permitted, which was contrary to what deregulation advocates had expected. The chess game between the business organizations and regulators in the US has been underway ever since. One of the focal issues is whether there should be a national cap for rates and what it should be. As in Su’s case, like in the US, many short-term high-interest loans turn out to be long-term rollover traps, the exact reason why similar lending products in both countries are labeled as “predatory” by many analysts and regulators. 

Girls use nude photos as collateral for borrowing from loan sharks

Expectation and Exit 

Whatever limits are imposed on debts, there must be legal remedy and exit mechanisms for people entangled in debt. In this regard, there are rising calls for making a law to regulate debt collection after the recent tragedy in Shandong. Currently, companies engaged in debt collection have to register as providers of other services, mainly business consultancies. But they publicly advertise their debt collection services online, and promise violence is not used. The most frequently reported and advertised ways of calling in debts are extortion, mainly by following debtors and their families wherever they go, or threatening to tell debtors’ bosses. In the “naked IOU” cases, P2P operators threatened the girls that their photos would be sent to their parents and friends if they failed to repay.  

Professor Li Shuguang at the China University of Political Science and Law urged the application of a bankruptcy law for individuals in 2002 when he drafted the law. However, his suggestion was not adopted. He and his colleagues proposed revising the law or introducing an additional law on individual bankruptcy during the annual sessions of national legislators in recent years. In Su’s case, as she owned the company as a natural person shareholder, she can still file for personal bankruptcy as the debt is used for the company’s operation. 

More importantly, as Li explained to NewsChina, things have changed over the years. With or without high rates, personal debts are very common in China now. Hundreds of millions of Chinese people hold credit cards and mortgages. According to the People’s Bank of China, by the end of 2016, the total amount of credit available via bank-issued credit cards had reached US$1.3 trillion, with US$7.7 billion of repayments being more than six months overdue. The balance of household mortgages had amounted to nearly US$4 trillion by the end of 2016. According to a report released by China’s Research Center for National Balance Sheet in April, the leverage of Chinese households has not only been increasing alarmingly quickly in the past two years, but has already become very high when measured by the ratio of households’ debt to their net wealth.  

Another new group who would benefit from a law to handle personal bankruptcy would come from the surge of small business startups encouraged by the government, as long as no more than 10 percent of them were to end up insolvent. Li pointed out the fact that a legal process of personal bankruptcy would give all those debtors a fresh chance to rebuild their credit record from zero and to then access capital, much better than being blacklisted by a court.  

The most important aspect of legally permitting personal bankruptcy, Li stressed, is to build a stable, clear expectation for both potential debtors and creditors when they consider a deal. As he explained, the existing 36 percent maximum cap of private lending is just a judicial explanation from the Supreme Court, not an article of a law. It must be made clear by the law that some debts of a person declared bankrupt are written off in the process of legal liquidation or reorganization. Potential lenders will then be more careful about choosing borrowers to avoid legal defaults or legal punishment if they use violence to collect the debts. This, he believes, can help deter rampant irresponsible lending and borrowing, though no law could completely erase a specific misconduct.  

If there were such a legal remedy and exit mechanism, it would probably have prevented the exit choice and subsequent legal process for young Yu Huan. For so many debtors and creditors in the high-interest lending market, the sooner such a legal alternative and exit is available, the less risk they will face of ending up in a situation like the recent tragedy in Shandong.