BEIJING/SHANGHAI Chinese companies are getting more creative in the business of money lending as they struggle to keep profits ticking over in a cooling economy, raising concerns they are adding to the mountain of debt risks building in the world's No.2 economy.
Big state companies in industries struggling with over-capacity but with easy access to credit are borrowing funds, not to invest in their business but to lend to smaller firms sometimes at several times the official interest rate, part of an informal lending market in China that authorities are taking aim at.
China's central bank increased pressure on banks to rein in such informal lending and speculative trading last week in money markets, letting short-term interest rates spike to extraordinary levels.
In the $3.7 trillion (2.4 trillion pounds) so-called shadow banking market, the fastest growing area is in so-called entrusted loans, which are arranged by banks on the companies' behalf, and in bankers' acceptance notes, tradeable securities that give a steady flow of cash.
Issuance of entrusted loans and bankers' acceptance notes has more than doubled to 1.6 trillion yuan (170 billon pounds) in the first four months of this year from 636 billion yuan a year ago.
"Can we use the money to expand production? Definitely not," said a deputy general manager at a state-owned steel firm in the eastern Shandong province, speaking on condition of anonymity.
"We will lose more if we produce more. We can only rely on other channels," he added, noting the firm loses an average 100-200 yuan per tonne of steel sold.
China's economic growth is widely expected to slow further in the current quarter as exporters struggle with weak global markets, making lending money an increasingly attractive business option.
But there are concerns that some of the money is going into areas the government would rather it did not, for example real estate speculation, raising the risk of it turning bad while not helping the economy out of its current slowdown.
Indeed, debt is shaping up to be China's biggest financial problem. The cabinet has said it would control the flow of new money into industries struggling with overcapacity.
Beijing worries the shadow banking market is creating asset-price bubbles, and the central bank has tried to put a barrier in the way of it in recent weeks by declining to inject major funds into money markets.
The shadow banking system has arisen because main stream banking is focused on the needs of big state-owned enterprises.
Ratings agency S&P has estimated that outstanding shadow banking credit totalled $3.7 trillion by the end of 2012, equal to 44 percent of GDP.
Fitch has put it at about 60 percent, saying "torrid growth" has made the total of all forms of credit, including regular lending, shadow and hidden underground lending, as much as 200 percent of GDP.
"This is a very, very big problem for the economy," said Wei Yao, China economist at Societe Generale in Hong Kong.
"The existence of all these arbitrage efforts shows that in the real economy, there are few opportunities. You've limited all the opportunities for real growth, then you open a window in the financial markets; of course everyone goes there!"
With entrusted loans, a company provides the funds but, to circumvent a ban on direct lending to other firms, it designates a commercial bank to lend the money to a specific borrower.
The lender stipulates the amount, tenor, and rate of the loan, while the banks earn fees from both sides without the loans showing up on their balance sheets.
The average monthly amount of new entrusted loans was 179 billion yuan in the first four months of 2013, up from an average of 106 billion yuan a month last year.
The steel company manager said he borrows from banks around the 6 percent official rate, then issues an entrusted loan to a borrower at up to twice that rate.
The general manager of a local government-controlled glass company in the northern province of Hebei said his company has increased the use of such practices as business slowed, lending about 30 to 40 million yuan so far this year at around 6 to 7 percent mainly to related firms.
Some private companies are also cashing in. Zhejiang Longsheng Group Co Ltd (600352.SS), a specialty chemicals maker based near Shanghai, detailed 50 entrusted loans worth 3 billion yuan outstanding in its 2012 annual report.
The company lent to subsidiaries at rates of 6 to 7 percent, but unrelated companies were charged as much as 25 percent. It said one of the loans, with a rate of 20 percent, would be rolled over as the borrower had difficulty repaying it.
Companies are also buying bank acceptance notes, transferable bills issued by other banks that can be sold for cash. These companies sell the bills and use part of the cash raised to make loans and the rest to buy more bills, thus ensuring a continuous churn of funds and income.
The average monthly amount of bank acceptance bills issued so far this year has more than doubled to 222.8 billion yuan compared with an average of 87.5 billion yuan for all of 2012.
REAL ESTATE A WORRY
A chief worry is that the newly generated money is finding its way into speculative real estate, complicating China's three-year fight against a property bubble. New home prices in May rose from a year earlier at their fastest pace in more than two years.
An official at the statistics department of the central bank's Dalian office, who asked not to be identified, said that among all the entrusted loans issued in 2012 in the northeastern city, about 30 percent went to the real estate sector at an average interest rate of 12 percent.
Another official at the central bank's Chongqing office said finance companies and credit guarantee firms affiliated to state-owned enterprises are major issuers of such loans.
"In our city, there is an estimated 50 percent or more of such loans flowing into the property sector and local government financing vehicles," said the official. "The injection of entrusted loans partially helps pull down the bad loan ratio in the property sector and local financing firms, but the risks keep brewing there and could become acute if the economy slows further."
(Reporting by Aileen Wang, Lu Jianxin and Pete Sweeney: Editing by Jonathan Standing, Vidya Ranganathan and Neil Fullick)