Shadow banking is a term that refers to the activities of financial intermediaries that operate outside the formal banking system. These intermediaries include trust companies, asset managers, micro-lenders, peer-to-peer platforms, and others that provide credit and investment services to various sectors of the economy. Shadow banking is often seen as a source of innovation and competition in the financial market, but also as a potential source of systemic risk and instability.
One of the main reasons why shadow banking is in trouble in China is the slowdown of the country’s economic growth, which has been weaker than expected in recent years. The COVID-19 pandemic, trade tensions with the US, regulatory tightening, and environmental challenges have all contributed to the deceleration of China’s economy. As a result, many borrowers, especially in the property sector, have faced difficulties in repaying their debts, leading to a wave of defaults and restructurings.
Another reason is the crackdown by Chinese authorities on the shadow banking sector, which has been ongoing since 2017. The regulators have imposed stricter rules and supervision on the activities and products of shadow banks, aiming to curb excessive leverage, reduce financial risks, and improve transparency. However, this has also squeezed the liquidity and profitability of shadow banks, making them more vulnerable to shocks and contagion.
How big is the problem and who is affected?
The problem is significant and widespread, as shadow banking accounts for a large share of China’s financial system. According to the People’s Bank of China (PBOC), the central bank, the size of shadow banking assets was 59.1 trillion yuan ($9.1 trillion) at the end of 2020, equivalent to about 60% of China’s GDP. However, some analysts estimate that the actual figure could be much higher, as some shadow banking activities are hidden or unreported.
The problem affects not only shadow banks themselves, but also their investors, clients, counterparties, and regulators. For example, many retail investors who bought high-yield trust products or wealth management products from shadow banks have suffered losses or delays in receiving their principal and interest payments. Many property developers and local governments who relied on shadow banks for financing have faced liquidity crunches and credit downgrades. Many banks and other financial institutions who had exposure or linkages to shadow banks have faced spillover effects and reputational damage. And many regulators who had to deal with the fallout of shadow banking defaults have faced challenges in balancing financial stability and economic growth.
What are some recent cases and what are their implications?
There have been several high-profile cases of shadow banking defaults or crises in recent months, which have raised concerns about the health and resilience of China’s financial system. Some of these cases are:
- Xinhua Trust: The first trust company to go bankrupt in more than two decades, Xinhua Trust filed for bankruptcy in May 2023 after failing to repay its debts. The company had about 100 billion yuan ($15 billion) in assets under management at its peak, but suffered from poor risk management and governance. Its bankruptcy has triggered legal disputes among its creditors, investors, and regulators.
- Zhongrong International Trust: One of the largest trust companies in China, Zhongrong missed payments on multiple investment products in mid-August 2023, sparking panic among its clients. The company had about 630 billion yuan ($97 billion) in assets under management at the end of 2020, but was hit by the default of Sunac China Holdings Ltd., one of its major borrowers in the property sector. The PBOC has reportedly asked Citic Trust Co., a subsidiary of China Construction Bank Corp., to assess Zhongrong’s financial situation and prepare for a possible bailout.
- Evergrande Group: The largest property developer in China by sales, Evergrande has been struggling to repay its massive debt load of over 2 trillion yuan ($310 billion), which includes a large portion of shadow banking liabilities. The company has been facing protests from its suppliers, contractors, employees, and investors who demand their money back. The company has also been under regulatory scrutiny for its alleged violations of the “three red lines” policy, which limits the leverage ratios of property developers. Evergrande’s troubles have sent shockwaves across the global markets and raised fears of a systemic crisis in China’s property sector.
These cases illustrate the complexity and interconnectedness of China’s shadow banking sector, as well as the potential spillovers to other parts of the economy and society. They also highlight the need for more effective regulation and supervision of shadow banks, as well as better coordination among different regulators and stakeholders.
