Local prosecutors in Wenzhou, ground zero for China’s growing credit woes, announced they have arrested a duo accused of running a shadow lending scheme. From China Daily:

The wife, Shi Xiaojie, was suspected of illegally accepting bills worth 500 million yuan and illegally raising funds of 700 million yuan. The husband, Liu Xiaosong, was suspected of illegally pooling public savings of 70 million yuan from more than 30 people. They were arrested on Oct 27, according to Shao Lulu, spokeswoman of the People’s Procuratorate of Yongjia County.

…

After graduating from college, Shi, 29, worked as a cashier in her uncle’s company, Shunji Group Co Ltd, a private construction company headquartered in Yongjia with a registered capital of 300 million yuan.

From 2007 she allegedly started to raise funds from relatives and friends in the name of the company. She used the money to give shark loans, accept bills and buy luxury properties and cars.

With a bulk of formal credit in China reserved for state-owned enterprises at off-market rates, private businesses have raised funds from banks willing to shirk their mandates in the name of higher returns. This market grew for years under the cover and prosperity of economic growth, but has now come under pressure as state-owned banks face their own tightening credit stream from Beijing. In the Diplomat, Minxin Pei discusses the origins of the shadow lending system and the its implications for China’s economy now that the tide has fallen:

The question on everybody’s mind is whether the massive leakage from the formal banking sector into the “shadow banking system” will be big enough to sink the Chinese financial sector. While nobody knows the real answer (in all probability, private firms are better risks than China’s traditional deadbeats, such as local government entities and SOEs), what makes a Chinese financial meltdown a more probable catastrophe would be a combination of several similar disasters. While each of them may be financially manageable in isolation, their total severity and simultaneous eruption could overwhelm the Chinese state.

Of course, here we are talking about the other two big holes in the Chinese financial system: local government debt (roughly 30 percent of GDP) and loans to real estate developers (the magnitude of which nobody knows).

So it appears that Chinese private entrepreneurs are not the only naked swimmers. They are in some distinguished company.

See also CDT coverage of Beijing’s attempts to address the shadow lending market, and the plight of entrepreneurs in Wenzhou, where a home grown version of Wikileaks has chronicled the effects of China’s credit squeeze.