China’s shadow banking system – Is it set to rebound despite government crackdown?

Earlier in June/July 2013, I wrote an article commenting on China’s shadow banking system following the Chinese Government crackdown on unlicensed lending activities, ‘underground’ marketing of unlicensed wealth management products/services, etc. The late June 2013 government crackdown caused the Shanghai interbank lending rates (SHIBOR) to spike up rapidly, sparking a week-long sell-off of global financial markets. Several Chinese banks have reported brief cash crunches, and some banks refused to lend to each other, which could have severely ‘frozen’ the capital/debt markets globally. The June crackdown was the result of several years of unregulated lending by some of the Chinese banks in the bid to increase loan volumes needed to sustain economic growth, particularly the real estate ‘boom’ most of us are still seeing it, despite various anti-property speculation measures implemented by the Central and provincial governments.

In a September 11, 2013 Bloomberg.com news article, there was a headline report quoted ‘China Shadow Banking Returns as Growth Rebound Adds Risks’. The article reported that on September 10, 2013, the People’s Bank of China (PBOC) issued a press release showed that aggregate financing for the month of August 2013 stood at approximately 1.57 trillion Chinese Yuan or approximately USD 257.0 billion. This figure topped estimates of approximately 950.0 billion Chinese Yuan in a survey conducted by Bloomberg News of 10 analysts. Traditional financing in the form of plain vanilla bank loans from banks accounted for approximately 45.0 percent of the total, down from July 2013’s figure of 87.0 percent, indicating that banks might have shifted their loan portfolios towards untraditional forms of lending, including the marketing of hedge funds, adding on more leverage through the approval of unlicensed loans to businesses, mainly in the industrials, retail, property, mining sectors, etc. to finance their respective projects.

The revival of the Chinese shadow banking system does not come as a big surprise for many market observers, as data has shown that Chinese firms are still finding means and ways to skirt around the rules and regulations governing the banking system in Chin. This trend also includes environmental, safety, food/water quality regulations, etc. The rise in credit growth is a growing concern for many market observers, and policy makers, as downside risks are tremendous, as a result of such increased leverage that many Chinese firms, and local governments take on. The credit bubble is also part of the causes leading up to the Asian Financial Crisis in 1997-1998, and the Russian Rouble Crisis in 1998-1999. Such increased leverage, if left unchecked, could potentially destabilise the global economy, particularly when China is regarded as one of the main engines powering global economic and trade growth at a time when many parts of the world are experiencing economic slowdowns, including India, Brazil, etc. The Sept 10 press release issued by PBOC also showed that M2 money supply (a widely-used gauge of the rate of monetary expansion by several monetary policy makers) growth accelerated to 14.7 percent, which was touted to be the fastest in three months.

The question remains on the revival of shadow banking system is why hasn’t the Chinese Government do more to regulate banks and financial institutions, including the tightening of credit growth, and unlicensed lending? Has the late June 2013 near meltdown of the Chinese financial system taught some lessons on these Chinese financial institutions? Would there be enough safeguards should there be a near total collapse of the Chinese banking system, sparking panic among domestic and global investors? Back in June 2013, several economic indicators including the HSBC Purchasing Managers Index (PMI), the official PMI numbers from the Chinese Government, infrastructure spending, inflation numbers, have pointed to an impending slowdown, or even a potential miss on the targeted 7.5 percent average economic growth as measured by the Gross Domestic Product (GDP) for 2013. The Chinese economy during the first half of 2013 did indicate a possible slowdown, but the various data pointing to an economic slowdown did not seem to correspond to the rate of credit growth which was needed to boost economic growth during boom years. With this latest revelation of the revival of the Chinese shadow banking system, does it pose many risks, including a potential credit collapse, and frozen debt markets? Have policy makers fully taken into account it’s responsibility of its actions so far in cracking the rising credit growth, particularly the potential consequences of ‘moral hazard’ shown by these Chinese financial institutions?

Based on a recent reading of some of the articles, and research conducted by Bloomberg, and other major investment banks, it appears that most have not revised their outlook for the overall GDP growth of China in 2013 which remains at north of 7.5 percent. Some of the reasons, I believe, could be the turnaround and gradual improvement in some of the Chinese industrial production numbers, including the latest reading of the HSBC PMI numbers for China (Bloomberg.com news article dated September 23, 2013) showing that the preliminary gauge had a reading of 51.2 for the month of September 2013, as compared to the actual final reading of 50.1 in August. However, the questions over an imminent credit collapse is still a possibility, though remote, as the Chinese Government is ready to step in and possibly ‘bail’ out these financial institutions. With the ratio of China’s debt to GDP rising to 187.0 percent in 2012 from 105.0 percent in 2000, this is quite a significant rise equivalent to analysing the rampant increase in credit growth which could impact a company’s solvency capabilities, and its ability to manage such debt levels.

In view of the revival of the rapid rise in the Chinese shadow banking system, there is no doubt that the Chinese Government is always on a lookout for any potential destabilisation of the economy. However, if one were to step back and evaluate the effectiveness of Chinese Government intervention on credit growth, I believe that there has been nothing of much significance being accomplished despite the tightening to the regulations pertaining to unlicensed lending by banks. I believe that there are always several rebuttals, and dismissals of such possible downtrends to the Chinese economy as shown by many of the Chinese economy optimists. However, I am still sceptical that the Chinese Government could find a permanent solution to the rise of the shadow banking system as Chinese policy makers have largely dismissed most concerns expressed by several investors, including the latest coming from James Chanos, a prominent New York-based hedge fund manager, when he was to be present for a Bloomberg News event in New York. During that event, various ‘bulls’ and ‘bears’ gathered for the annual summit of prominent financial thinkers, and speakers, including Mr. Chanos, a widely-touted Chinese bear, and was one of the key analysts that accurately pointed to a collapse of energy giant, Enron, Inc. in 2000. Mr. Chanos has expressed his pessimism on China’s continued economic growth, especially with the various potential negative impacts of such unlicensed lending practices that will likely cripple the Chinese lending system, and the potential destabilising factor to global economic growth for many years to come. I believe that his take on the Chinese economy should not be discounted, as there has not been any true government-wide reforms on regulating the Chinese shadow banking system forcefully. I believe that this revival of the Chinese shadow banking system is going to remain a widely debated topic for many years to come.

About Hock Meng Tay - Chief Editor, Asia-Pacific Region

Hock Meng Tay, CAIA has written 181 post in this blog.

Chief Editor, Asia-Pacific Region Hock Meng Tay is a CAIA holder and is currently taking CFA qualification. He has over 10 years of experience working as research associate in several investment companies.He is an expert in financial analysis and has published research reports in his current role. He obtained his Masters of Business Administration in Integrated Management and Masters of Arts in Economics while serving his internship in Starsource Inc

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