For more than a decade, the boom Construction industry in China has been fueled by ‘tons’ of debt. The developers borrowed from so-called Chinese shadow banks that grew rich during the housing boom. This industry took advantage of developers desperate for credit that traditional banks refused. As China’s housing and real estate sector begins to deflate, shadow banking could be the first part of the financial sector to suffer the hangover of past excesses. Financial turmoil in the West could put the finishing touches on this faded and mysterious financial industry.
With this banking turbulence still very present, there is a fear that the scenario after the rapid interest rate hikes by central banks will end with something else broken. One of the biggest candidates, for many analysts the first, is what is known as shadow banking (shadow banking) in English. The growing operations of these non-bank financial institutions are of great concern. If the Allianz economists already see in the sector the next “financial crash”, those of the IMF have once again warned in their latest financial supervision report of the risks that it brings together. Within that threat, the situation in China is remarkably alarming.
The economists Francisco del Olmo, Diego Aires, Fernando Rojas and Antonio Mota explain in a Funcas publication that “it is considered shadow banking or shadow banking to entities that carry out credit activities outside the regulated banking sphere, but which, since they do not directly capture deposits and, therefore, the savings of families and companies, would not be regulated in the same way as commercial banks traditional”.
In a recently released report, the Center for Strategic and International Studies (CSIS), a think tank American, warns that China faces “rising risks of financial crisis” with shadow banking as the epicenter of its debt problems.
Everyone knows it exists, but no one knows exactly how big it is or what its balance sheets are made up of. Some approximations emerge: loans granted by companies that do not have a banking license have reached 50 billion yuan ($7.3 trillion), or about 42% of Chinese GDP, according to Moody’s.
Firms in the shadow banking industry, also known as trust companiesNow, after years of expansion, they are facing an opposite trend, which is forcing these entities to look for new businesses, including direct investment in companies, family offices and asset management. Furthermore, in an attempt to survive, the shadow banks have begun to make very painful adjustments, destroying jobs and lowering wages.
These firms are suffering greatly, which in turn is affecting employees who were once among the highest paid in the industry and are now leaving for other jobs. The difficult situation of the industry stands in stark contrast to China’s major financial firms, which do not belong to shadow banking or shadow bankingwhich the crisis has not yet seriously affected.
“Everyone is fighting for a mouthful of rice, surviving another day,” he tells Reuters Jason Hao, who left his job at such a firm this year after his salary plummeted from as much as four million yuan ($570,000) a year to about 240,000 yuan ($34,000). He now works at another asset management company.
To the above are added the ups and downs of the economy China, whose data is contradictory to say the least. On the one hand, the advisers of the People’s Bank of China (PBOC, the central bank) have come to propose the ‘money helicopter’ to stimulate consumption that does not wake up after the covid crisis. This narrative would be consistent with the low inflation that the country is experiencing. However, recently it has been published that credit is recovering in China, which would not make sense with what was said above.
“Credit dynamics have exceeded expectations for three consecutive months in China. In March, monthly aggregate financing flows – a broad measure of overall credit in the economy – rebounded more strongly than in previous years, buoyed by strong credit flows. lending, strong government bond issuance and a rebound in shadow bank lending,” reflects Susan Joho, economist at Julius Baer.
The point is that China’s economy is not fully recovering, while the rest of the world it faces the possible arrival of a recession caused (at least with help) by the financial sector. Although the ramifications are not very extensive, turbulence in the financial sector on one side of the world may even end up reaching China through the confidence of investors and other agents.
Of those powders…
The story goes back to the years of the Great Financial Crisis. It was China’s attempt to insulate itself from the ensuing global recession that led to its own debt affair, says Logan Wright, author of the CSIS report. China’s stimulus package was officially put at $588 billion, or 13% of the country’s GDP at the time, but the real effect was much larger because the government relied on the banking system to make loans as well as disbursements. direct prosecutors.
“Banks were encouraged and did lend aggressively to all types of borrowers, but particularly to those that were state-owned,” Wright writes, noting that by the end of 2012, the size of the Chinese banking system had shrunk. had doubled in terms of assets in just four years. The Chinese political class ignored the financial risks that accompanied such breakneck growth because of the benefits of increased output and employment.
Meanwhile, state control over the financial system of the economy led market participants to believe that the government would step in to prevent the severe losses that could result from increasingly risky lending. These conditions led to a wave of financial speculation, indirectly encouraged by the PBOC, the Chinese central bank), says Wright. “By regularly intervening to keep money market rates low and stable, the central bank encouraged shadow banks not only to borrow aggressively in money markets at low rates, but also to add leverage to their positions to generate yield. “.
The People’s Daily warned him in 2016: “A tree cannot grow to the sky”
In 2016, Chinese regulators took notice that the unregulated growth of the shadow banking system threatened to create financial instability while wresting control over credit allocation from the state. The leaders of the Chinese Communist Party were therefore “forced to contemplate difficult decisions on how to slow the growth of global debt and reduce the shadow banking system without affecting the broader economy too badly, which could trigger unemployment and discontent.” social,” according to Wright. “A tree cannot grow to the sky, and high leverage carries great risks. Mismanaged, it will lead to a systemic financial crisis,” warned the People’s Daily itself, the information organ of the Communist Party of China.
The campaign largely succeeded in stabilizing debt levels across the Chinese economy, but led to a sharp drop in economic activity starting in 2018 and a scramble among property developers to replace shadow bank financing. Chinese property developers began financing their operations through pre-construction home sales, shifting their borrowing from shadow banks to prospective homeowners. The rest is well known: collapse in the real estate sector and families revolting and refusing to pay their mortgages for properties not yet built.
“In theory, the expansion of the shadow banking sector could be positive if it helped to diversify financial risks. However, this has not been the case in China as the activities of the shadow banking have been channeled towards financial vehicles and practices with high risk, and many times with the participation of the formal banking sector”, explains Javier Garcia Arenas, economist at CaixaBank Research. “A disturbing element to take into account is that many traditional banks, with the help of shadow banking, have reclassified loans, many of them doubtful, into other financial products that require much smaller provisions. as sayings reclassified loans In reality, they present a high risk that has not been adequately provisioned and the banks have not been able, in many cases, to transfer the risk, this practice could generate significant tensions in the financial system”.
… these sludge
As the columnist echoes Bloomberg Shuli Ren, “paranoid about its huge debt pile – China’s total debt-to-GDP ratio hovers around 300% of GDP – the government is keen to assess banks’ exposure to shadow financiers.” For example, we know that small banks are net lenders, which puts them at the forefront of contagion risks. But the task is not easy and the dynamic continues to grow.
“The only effective tool to manage the debt burden is restructure it at lower interest rates, which will likely involve financing from the central bank’s balance sheet. This also means that key central bank interest rates and critical refinancing rates will have to decline over time. In a highly indebted system, there are few options to significantly raise interest rates without unleashing immediate financial stress,” Wright summarizes. For the expert, the political imperative of the decisions and concern about the global perception of the Chinese economy may prevent them from Chinese financial authorities take the necessary measures to ensure systemic stability in the future.
Although the Chinese authorities have various policy tools at their disposal in the event of a financial crisis, such as central bank emergency liquidity facilities, forced restructuring of commercial banks or other financial institutions in distress, and direct interventions in financial markets to prevent contagion finance, remarks the CSIS expert, “the problem facing the Chinese leadership is that the use of these measures It clearly indicates that China is facing a financial crisis intrinsic to its growth model and past decision-making, and affecting the Chinese system as a whole.”
