China pawnbrokers cash in on funding gap

By Simon Rabinovitch in Beijing

Visitors to Baoruitong, China’s biggest pawnbroker, are greeted by display cabinets of Swiss watches, diamond rings and jade ornaments. But the real action is in the private offices at the back, where agents appraise the value of much larger objects – houses and cars – as collateral for loans.
“If pawnshops have one distinguishing feature, it is that we are highly efficient,” said Dong Yi, Baoruitong’s operations manager. “We once lent a client Rmb10m ($1.6m) within four working hours of him coming to us

“If you bring your car here, we can get you money within one or two hours at most.”
Baoruitong is not alone. Throughout China, pawnshops have branched out a long way from their roots of swapping relatively small loans for collateral such as jewellery. They have become key players in an important corner of the country’s economy as lenders of last resort to small businesses, an activity where stakes are much higher.
Small businesses, which struggle to get loans anywhere in the world, are particularly disadvantaged in China where state-owned banks shy away from private companies. The transformation of pawnshops into quasi-banks offers a glimpse into the shortcomings of the Chinese financial system, but also the ways in which entrepreneurs are coming up with solutions.
Banned by the Communist party until 1987, pawnshops are now thriving. China had 4,433 pawnshops at the end of 2010, more than double the number five years ago, according to the most recent official data.
“At first I wasn’t that happy about joining the pawnshop industry. It seemed a bit too simple. You swap some money for an object, right? But that was a traditional view. Once inside, I saw it wasn’t like that. Pawnshops have been upgraded,” Ms Dong says at Baoruitong’s Beijing headquarters.
Only about a 10th of Baoruitong’s lending is what is conventionally thought of as pawning. Up to 60 per cent is backed by property and 30 per cent by cars, with almost all of that money going to the owners of small businesses. Other pawnshops report similar figures.
They are answering a need. Despite China’s phenomenal economic growth, its financial system remains stunted. Banks’ profits are effectively guaranteed by government policy, making them extremely risk averse. They prefer to lend to state-backed enterprises, fearing private companies could be allowed to fail if trouble strikes.
China has thousands of vigorous companies which, ignored by banks, are willing to pay high rates for loans. Sensing opportunity, cash-rich businesses such as industrial groups, private equity firms and peer-to-peer websites have started offering loans to the “unbanked”.
Analysts say this informal lending could total as much as Rmb10tn, or about one-fifth of bank lending, and small businesses appear to have become even more reliant on it over the past few years.
Pawnshops have been some of the most aggressive, bolstered by their national networks of store fronts and experience in short-term lending.
They lent Rmb180bn in 2010, equivalent to just 2.3 per cent of lending by banks but a figure that is rising quickly. While bank loan growth has been about 20 per cent annually, pawnshop managers say their loan books have been doubling every year or two.
The combination of rapid lending growth and relaxed credit standards inevitably raises questions about risks.
Regulators are not blind to this. They have pushed for greater disclosure of lending outside the formal banking system and tried to insulate banks from such activity. But their attitude has largely been permissive and their main focus on improving monitoring.
“If the regulators were truly concerned that this could be a source of systemic risk, they would have clamped down long ago,” says Tan Kim Eng, analyst with rating agency Standard & Poor’s.
A pilot project launched last month to allow private lending in Wenzhou, an entrepreneurial hub in the eastern province of Zhejiang, was seen as an important step towards establishing standards for non-bank lending institutions.
Pawnshops fall under the purview of the commerce ministry, which issues strict guidelines about interest rates. A property-collateralised loan is capped at 3.2 per cent a month, which works out to a hefty 46 per cent annualised rate – a seemingly punitive level. But the financing is only meant to be for a few months and businesses have lapped up the pawnshop loans.
“So far the regulators’ view is that the current banking system is unfavourable to financing for small and medium-sized enterprises,” Mr Tan says. “Therefore if non-bank institutions are able to plug part of this gap, it’s not necessarily a bad thing.”