Yesterday I had an interesting lunch with a Chinese investor. We were discussing the informal banking sector in China, and he agreed that it seems to have grown a great deal in the recent past. Interestingly enough, according to him, loans to real estate developers had become a particularly important source of growth for these banks, which is perhaps not surprising given lending caps and attempts by the PBoC [People's Bank of China] to discourage the commercial banks from taking on more real estate exposure.
He told me that he believed that the highest quality real estate developers were able to obtain one-year funding for around 15% which, given CPI inflation of around 8% (probably understated by 1-2%) and PPI inflation of around 9%, represents, I think, a reasonable borrowing cost for a prime creditor in a developing economy. Lower-tiered real estate developers, however, were paying 80% for one-year money, which is consistent with some of the other numbers I have heard. Very few of the real estate developers would be considered prime enough to get the lower cost funding.
Needless to say 80% is a pretty high cost of funding, and almost certainly requires rising real estate prices in order to be economically viable. In case of an economic contraction or declining real estate prices, I would assume that a lot of these real estate developers would face severe debt-servicing difficulties. We discussed what would happen in the case of a default – besides the proverbial visit by the man with a baseball bat he suggested, with a completely straight face, it was also likely that one of your kids might be kidnapped.
This kind of collection process strikes me as a reasonably strong argument for lower default rates in the Chinese informal banking sector than in the formal sector, at least in the initial stages of a contraction, although it also suggests that the Chinese banking habit of deferring losses might not work here. On the contrary, I expect that payment difficulties would lead to significant selling pressures as real estate developers try to raise cash as quickly as possible to meet their obligations (and get their kid back). I guess that in areas characterized by large informal banking sectors, real estate price corrections are likely to occur much more rapidly than in places like Beijing, where I think the informal banking sector is relatively much weaker.
That's the kind of collection process I'd expect in Russia, too. Ah, capitalism.