Shadow bank­ing nec­es­sary to fill gap, ex­pert warns

China Daily (Canada) - - ACROSS AMERICA - By AMY HE in New York amyhe@chi­nadai­

A new doc­u­ment out­lin­ing tighter con­trols over shadow bank­ing ac­tiv­ity re­port­edly has been cir­cu­lat­ing with China’s fi­nan­cial reg­u­la­tors, but Sun Mingchun, chief econ­o­mist and found­ing part­ner at eq­uity-hedge fund China Broad Cap­i­tal, said that while more reg­u­la­tion is nec­es­sary, shadow bank­ing is fill­ing a fi­nan­cial gap that tra­di­tional in­sti­tu­tions can­not.

“Shadow bank­ing: this is a topic that kept in­vestors awake over the past few years — China in­vestors. Ac­tu­ally, last night, I was kept awake by the Asia mar­ket, which dropped by 1.8 per­cent,” said Sun. In two days’ time, the Asian in­dex dropped 4 per­cent­age points, which Sun at­trib­uted to ru­mors of new shadow-bank­ing reg­u­la­tion.

Shad­ow­ing bank­ing ac­tiv­ity has led to sev­eral credit crunches dur­ing 2013, caus­ing the cen­tral bank to in­ject liq­uid­ity into the fi­nan­cial sys­tem and rais­ing in­ter­bank lend­ing rates to record highs.

The China Se­cu­ri­ties Jour­nal re­ported this week that the cen­tral gov­ern­ment had cir­cu­lated a new doc­u­ment de­tail­ing shadow bank­ing and how it in­tends to reg­u­late ac­tiv­ity that has been con­ducted by th­ese non-tra­di­tional fi­nan­cial in­sti­tu­tions.

An of­fi­cial from the Peo­ple’s Bank of China, the coun­try’s cen­tral bank, told China Daily that he could not con­firm the ex­is­tence of the doc­u­ment. The China Bank­ing Reg­u­la­tory Com­mis­sion said that while it hasn’t re­ceived the doc­u­ment yet, it has “no­ticed re­lated me­dia re­ports.”

In the doc­u­ment, ac­cord­ing to the news­pa­per, reg­u­la­tors listed three cat­e­gories of shadow bank­ing en­ti­ties: the first are un­li­censed fi­nan­cial in­ter­me­di­aries, the sec­ond are li­censed but not suf­fi­ciently reg­u­lated, and the third are li­censed fi­nan­cial en­ti­ties that have parts of their busi­nesses in­suf­fi­ciently reg­u­lated.

Sun — who made his re­marks on Mon­day at a 2014 eco­nomic fore­cast event hosted by the Na­tional Com­mit­tee of US-China Re­la­tions held at the New York Stock Ex­change — said he’s not wor­ried about the im­me­di­ate fu­ture of shadow bank­ing, which he be­lieves is nec­es­sary for the Chi­nese econ­omy. Shadow banks are pla­cat­ing a fi­nanc­ing gap that Sun said is grow­ing larger and larger.

“You look at China’s fixed-as­set in­vest­ment, ver­sus an­nual new loan growth in the past eleven years. The amount of in­vest­ment in­creased by 11 times, the amount of loans in­creased by four to five times,” he said. This gap, he said, is caused by the fi­nanc­ing needs of the econ­omy and the re­straints of how much the for­mal bank­ing sys­tem and cor­po­rate sec­tor can pro­vide.

Ex­ces­sive reg­u­la­tion is also lead­ing to quick­en­ing de­mand of shadow banks’ re­sources, Sun said. The IPO mar­ket is still shut down, the bond mar­ket in China is small, and there are no mu­nic­i­pal bonds yet — “De­vel­op­ers can­not use eq­uity mar­ket for fi­nanc­ing for many years,” he said.

China needs to in­vest up­wards of $11.6 tril­lion (70 tril­lion yuan) each year, Sun re­marked, but the coun­try’s GDP to­taled $8.6 tril­lion (51.9 tril­lion yuan) in 2012, mak­ing it hard to bridge that gap with­out re­ly­ing on shadow banks.

That isn’t to say that the sys­tem is with­out its prob­lems, like the dou­bledigit in­ter­est rates for loans, which Sun said is “con­cern­ing,” be­cause “not many projects can have high re­turns” enough to make up for the high in­ter­est rate. Sun also rec­om­mended that sys­tem be more in­sti­tu­tion­al­ized and be made “more trans­par­ent,” though he did not spec­ify how.

But with­out shadow bank­ing, China could have hit a sud­den drop-off in growth much faster, he said. “I have to say, over the past few years, with­out the fi­nanc­ing pro­vided by the shadow bank­ing sys­tem, we could have al­ready had a hard-land­ing in China,” Sun said. “We won’t be able to get 7.5 or 8 per­cent GDP growth in the past two, three years.”

Sun pre­dicted that de­fault is com­ing in the near fu­ture, but views that as a good thing and re­mains op­ti­mistic about the shadow-bank­ing sys­tem’s prospects. “We need to have some de­fault to nor­mal­ize the credit spread. We don’t re­ally have a good spread in China to­day,” he said. “But on the other hand, I don’t think sys­tem­atic im­plo­sion is likely in the next one or two years.”

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