In China’s Alleyways, Underground Banks Move Money

SHENZHEN, China – In a warren of tiny shops beneath grimy residential towers, a white-haired man selling Snickers bars and fizzy drinks from a kiosk no larger than a cashier’s booth is figuring out a way to move $100,000 out of China.


That is twice what Chinese are allowed to send out of the country in a year. Licensed banks won’t do it. But middlemen like Mr. Chen, perched in his mini-mart at the front lines of a vast underground currency-exchange and offshore-remittance network, can and often will.


“There’s never a certainty that these things can be done,” said Mr. Chen, who declined to give his full name. “But, usually, when things get stricter, the fee will just be a bit higher.”


Facing a turbulent stock market and a weakening economy, many Chinese are trying to move money offshore. That spells business for operations that can end-run capital controls.


No official data track the underground transfers, but central-bank officials who attempt to say that underground banks handle about 800 billion yuan ($125 billion) annually, and more than usual this year.


One sign of unusually high activity in underground banks is a drop in China’s foreign-exchange reserves, an indicator of demand for hard currency. Reserves fell by a record $93.9 billion in August and $43 billion more in September, though part of the reason was central-bank selling to support the yuan.


Often hidden behind the façades of convenience stores and tea shops, they cater to a clientele ranging from corrupt officials hiding gains to middle-class Chinese trying to buy overseas property. All believe their money is safer abroad or can bring a higher return, a sentiment that has deepened since this summer’s stock-market plunge.


New York real-estate agent Jiang Jinjin estimated that families of nearly 2,000 Chinese students at Columbia University are looking to buy residential properties. “I didn’t sleep much this summer. Too many kids looking for apartments,” she said.


Some customers rely on relatives and friends to carry cash over on repeated trips, she said, and some set up U.S. companies. Such firms can be used to overpay for imports, experts on underground banking say. Ms. Jiang said her company checks the provenance of money used to buy real estate.


The outflows have put underground bankers in China in the cross hairs of financial regulators. China’s capital controls were set up to keep funds onshore when the country was starved for investment. Officials consider them still necessary, to prevent sharp outflows of the kind that shocked developing economies in the 1997 Asian financial crisis. Also, too much cash going out could complicate efforts to stimulate growth through interest-rate cuts.


“It’s a sign of a loss of confidence in China’s economic outlook, and it certainly makes it more difficult for the central bank to achieve their reform goals,” said Julian Evans-Pritchard, an economist at research firm Capital Economics.


For years, underground banking thrived in Shantou and Chaozhou, fiercely entrepreneurial coastal cities that were rife with smuggling, counterfeiting and drug and gun running. Much of the activity has moved to cities near the border with Hong Kong and Macau, former foreign colonies with more-open financial systems. Once mainland money gets to Hong Kong, for instance, it can go pretty much anywhere in the world.


Sometimes, large sums are divided into legally allowed amounts and then channeled out of the mainland via hundreds of bank accounts controlled by the underground banker. Underground banks also can match yuan deposited with them on the mainland with equivalent amounts in foreign currency paid into a client’s bank account elsewhere.


These informal networks, like hawala agents in the Arab world, also enable Chinese workers overseas who can’t open regular bank accounts to send funds back to China.


The Chinese government says it isn’t rattled by the current bout of outflows, which top officials describe as “normal.”

Another sign of a pickup in underground activity: Investment in foreign commercial property by Chinese is on track to surpass last year’s $10.5 billion, according to U.S. property-services firm CBRE Group.


The Chinese Ministry of Public Security said in August it was stepping up a campaign against underground banks, contending “gray capital” spirited out worsened the summer stock swoon.


The crackdown has made underground-bank runners much less visible on Shenzhen’s Xixiang Pedestrian Street. But a walk along the street turned up one, whom shop owners nodded toward when asked who was a runner. It was a young man in yellow loafers named Zhuang.


“Xixiang used to have so many people who would change money for you,” Mr. Zhuang said, at his spot in an alley between a bakery and a clothing store. “A lot of people have been caught.”


In June, Shenzhen police raided an underground bank on the street, arresting 31 and seizing 1,087 accounts holding 12 billion yuan.


The case offered an underground-banking primer. It began in 2012 when Chan Tat, an elderly Hong Kong businessman, sought to move 63 million yuan from his mainland business to Hong Kong for his retirement, according to an account given by Shenzhen police.


Mr. Chan tapped a friend at a commercial bank, who turned to a Shenzhen underground bank. It split the money into three batches. Each was divided into dozens of smaller chunks, then routed to separate bank accounts controlled by the underground bank, before being wired to Hong Kong. Once in Hong Kong, the money was regrouped in an account controlled by Mr. Chan.


All except for eight million yuan he found missing. Mr. Chan, who couldn’t be reached for comment, tipped off Chinese authorities, according to the police account. It isn’t known what has happened to the 31 people arrested.


With direct remittances under scrutiny, runners say a preferred method is matchmaking: Give the underground bank a sum, and a matching sum appears in Hong Kong, minus a cut of anywhere between 0.3% and 3%. No money physically or electronically crosses the border; the match is built on networks on both sides controlled by the underground bank.


The networks make use of family and village ties, said a researcher in the central-bank’s anti-money-laundering unit. “People create and control hundreds of accounts by going into villages to buy national identification cards” from the poor, the researcher said. The accounts surface and vanish.

In a fraud case in Hong Kong courts, prosecutors described how a man named Yang Sigai allegedly set up and then closed three bank accounts there. Though none was open longer than seven months, more than 1,000 transfers totaling about $60 million passed through them, according to court records.


The business was upended after a batch of incoming funds allegedly included $1 million bilked in a phone scam from a Canadian-Chinese man. After he alerted Hong Kong police, they traced the funds to Mr. Yang, who was convicted of fraud, a decision he is appealing. He couldn’t be reached.


The underground banks near Shenzhen’s railway station are more cautious now but undaunted. When asked about transferring $100,000 offshore, a store operator in the back room of a cigarette shop ruled out electronic transfers, offering instead to have people physically mule it across in small batches.

“The policy pressure is high this year, so the risk is higher,” he said. “Unless you know people.”