Much attention has centred on the ballooning debts owed by local governments in China to state banks. Less noticed, though, is the surge in defaults among a vast network of unregulated underground banks in recent months, a development that threatens to further crimp credit supplies to the private sector.

According to research over several months by FT China Confidential, non-performing loans at 50 underground banks surveyed in seven provinces have been climbing steadily since early 2011. In April, May and June, the proportion of underground banks reporting a rise in bad loans from the previous month were 22 per cent, 19 per cent and 15 per cent, respectively – representing clearly elevated levels from the near zero increases registered in the first two months of the year.

Underground banks inhabit the twilight of China’s financial system. Though unregulated and often unregistered, they regularly advertise for clients and depositors in local city newspapers. A couple of years ago, such adverts would typically be small, somewhat furtive notices offering “quick funds” next to a single mobile phone number.