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Originally published Saturday, April 21, 2012 at 8:02 PM

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China's shadow banking business is on trial

The Supreme People's Court is reviewing the 2009 verdict against 30-year-old Wu Ying and will decide as early as this month whether she lives or dies.

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BEIJING — When a Chinese court sentenced 28-year-old Wu Ying, known as "Rich Sister," to death for taking $55.7 million from investors without paying them back, it sparked an unexpected firestorm that has drawn in China's top leadership.

Her crime involved a common, illegal practice in China: raising money from the public with promises to pay back high interest rates. Known as shadow banking, these underground lending and investing networks are estimated to total $1.3 trillion, according to Ren Xianfang, an economist with IHS Global Insight. That's the size of the 2011 U.S. government deficit.

Operating outside the banking system or government regulation, the informal networks provide an important source of economic growth, capital for private companies and return for investors seeking to beat inflation. Premier Wen Jiabao, in an unusual move, weighed in on the case at a news conference last month. His comments highlighted a public debate over the importance of shadow banking to the Chinese economy, government efforts to bring it under control — and whether capital punishment is an effective means to do so.

"Chinese companies, especially small ones, need access to funds," Wen said when asked about Wu's case. "Banks have yet to be able to meet those companies' needs, and there is a massive amount of idle private capital. We need to bring private finance out into the open."

Singled out

Wu's lawyer says his client, now 30, was unfairly singled out and is no different from the estimated 42 million Chinese business owners who rely on the shadow-banking system for financing when they cannot get loans from state-owned banks. The Supreme People's Court is reviewing the 2009 verdict and will decide as early as this month whether Wu Ying lives or dies.

"Entrepreneurs are paying attention to it because today's Wu Ying could be any of them tomorrow," the lawyer, Yang Zhaodong, said last month. "There are so many of them doing the same thing Wu Ying did. This case not only relates to Wu's life, but to whether China's legal and judicial system is fair."

Shadow banking has been fueled by a two-year credit squeeze in China and by large, state-owned banks' preference for lending to government-run companies rather than small businesses. Private entrepreneurs account for 60 percent of China's total economic activity and provide jobs for 80 percent of its urban population, according to China's National Development and Reform Commission.

"Underground banking filled the hole left by China's state-owned banks, which have this long-term bias toward big enterprises," said IHS's Ren. "Even though it is an extremely opaque market and has a lot of hidden problems, the government needs it to meet the basic financing needs of small businesses."

Meteoric rise, fall

Wu's rise and fall have been meteoric. The daughter of a farmer in Zhejiang province, south of Shanghai, Wu dropped out of technical school to work at her aunt's beauty salon and later opened two of her own, according to the state- run Global Times newspaper. She branched out into a foot-massage parlor and bought 10 cars to rent out. An entertainment center, a clothes boutique and investments in real estate and copper followed, the report said.

Wu collected 770 million yuan ($122 million) from private investors between May 2005 and February 2007, according to government prosecutors. She also accumulated more than 100 properties and 40 cars, including a $500,000 Ferrari, the Global Times said.

Wu borrowed money to fund her businesses and didn't lie to anyone, her lawyer said. She never committed fraud, Yang said, adding that her investors, like anyone who took part in the private-banking business, knew the risks involved.

"Even her biggest creditor who she owed 320 million yuan doesn't think Wu was lying to her," said Yang. "These were real projects."

The court in Wu's home province of Zhejiang said she "brought huge losses to the nation and people with her severe crimes and should therefore be severely punished" when it upheld her death sentence in January, according to the Xinhua news agency.

Nicknamed "Fu Jie," or "Rich Sister," in the media, Wu and her case were discussed at the annual legislative session in Beijing last month, where delegates debated the larger issues of shadow banking.

"You cannot try to stop this just by killing people," Wang Yongzheng, a delegate to China's People's Political Consultative Conference and owner of a textile company, told a small group session.

In a country where public criticism of government policy is rarely sanctioned, state-run media outlets such as Xinhua and the People's Daily, both Communist Party mouthpieces, have run stories, editorials and online chat sessions airing public sympathy for Wu.

On Feb. 8, the China Daily newspaper ran an article noting "wide sympathy and pleas for" Wu, and quoting a legal expert as saying the seizure and sell-off of her assets was illegal.

As the public outcry began to swell, court officials and police took the rare step of publicly defending their verdict. The presiding judge in her case, Shen Xiaoming, appeared in a Feb. 7 Internet chat to explain that Wu was sentenced to death because the court found she intended to defraud investors, noting, "This was more than just illegal fundraising."

Too big to ignore

China's entire shadow-banking system is bigger than just underground borrowing and lending, totaling about $2.4 trillion, a third the size of China's official loan market, according to Société Générale economist Yao Wei. In addition to informal lending, it includes the off-balance-sheet activities of banks, trust companies, and businesses lending to one another, Yao said. The amount is almost the size of U.S. consumer debt, which exceeded $2.5 trillion as of January, according to the U.S. Federal Reserve.

Ordinary Chinese savers also fuel the country's shadow-banking system. They have few legal options if they want to earn a return that beats inflation, which hit 5.4 percent in 2011. The government sets China's current ceiling for savings-account interest rates at 3.5 percent, a figure that has trailed inflation for two straight years as of January. Wu offered interest rates of as much as 0.5 percent a day to attract investors, according to Xinhua.

Zhejiang province, where Wu's home village of Dongyang is located, has been at the heart of private lending activity. Between April and September last year, more than 80 indebted businessmen committed suicide or declared bankruptcy in its boomtown manufacturing city of Wenzhou because they couldn't repay informal lenders, according to Xinhua.

The government stepped in to deal with the troubles and bring some aspects of shadow banking under government control. In October, Premier Wen traveled to Wenzhou, a city of 9.1 million people 230 miles south of Shanghai, pledging help for troubled businesses. Then, on March 28, China's State Council approved a pilot program for Wenzhou that would ease some restrictions on private lending.

Private capital will be encouraged to participate in "innovative financial organizations" such as credit unions, and banks will be encouraged to lend money to small enterprises, the State Council said.

"The Wenzhou trial program has started us on the right track," Zhou Dewen, president of the Wenzhou Small and Medium Sized Enterprises Development Association, said the day after the announcement. "The trial program is a step forward toward making private lending a practice that's legal."

By the time Wu was in her mid-20s, she had founded the Bense Holding Group and established 12 companies, according to a profile in the Guangzhou-based Southern Weekly. A Feb. 1, 2007, profile said she couldn't explain where her wealth had come from.

"I don't launder money," Wu said, according to the newspaper. "My money is clean."

Less than two weeks after publication, authorities announced that Wu had been arrested on suspicion of illegal fundraising. The charges were later upgraded to financial fraud, a crime punishable by death in the most severe cases, for losing 380 million yuan of investors' money. Two years later, she was sentenced to die.

The court found that Wu raised her money by "fabricating facts, deliberately hiding the truth, and promising high returns as an incentive," according to Xinhua.

Photographs of Wu in court show her clad in a yellow prison jacket, sobbing. She has been in prison appealing her conviction since her 2007 arrest. Xinhua reported in April 2011 that Wu was writing a book called "Black Swan," a fictional account of her life, while in prison.

Wu wouldn't be the first shadow banker to be executed in China. In 2009, the execution of two female entrepreneurs in separate cases were approved. Si Chaxian, age unreported, was charged with defrauding 300 people of 167 million yuan over five years and promising returns of as much as 108 percent annually. Du Yimin, 44, was charged with defrauding 709 million yuan by promising to pay as much as 10 percent per month, the official CCTV reported.

At least 17 people, including Wu, now sit on death row after being sentenced for illegally raising money from individuals, according to Chinese media reports compiled by Bloomberg since 2009. Seven are women.

Wu's case, unlike the two executions, 16 other death sentences and numerous arrests, has struck a chord and spurred a broader national debate.

"She's not some sort of privileged person who just had everything handed to her," said Sarah Schafer, a Hong Kong-based researcher with Amnesty International. "People see her as someone who is closer to them than they care to admit."

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