Alarm at rise in China’s shadow banking sector

CHINA’S central bank has revealed shocking figures on the scale of shadow banking operations in the country, admitting that off-balance sheet business is more than double previous estimates.

Bank assets are approaching $38 trillion (£29 trillion). The explosive growth of hidden activities on the margins of the financial system has alarmed the People’s Bank (PBOC), and suggests that the two-year credit spree since the downturn in early 2015 is treacherously unstable.

The Chinese version of the PBOC’S Financial Stability Report – not yet available in English – shows that the shadow banking nexus is bigger than all other regular activities of the lenders put together.

Regulators had thought it was equivalent to 42pc of on-balance sheet business at the end of 2015. They have revised this drastically, admitting that it reached 110pc by the end of last year.

Xi Jinping, China’s president, called for a hard-headed campaign to curb systemic risk and to flush out “zombie companies”, warning over the weekend that financial stability was a matter of urgent national security.

It is the first time that a Chinese leader has been the chairman of the National Finance Work Conference – held every five years – and is a sign of rising alarm as debt reaches 280pc of GDP. He said local party officials will be held accountable for the rest of their lives for debts that go wrong. Any failure to identify and tackle risks will be deemed “malfeasance”.

For now the economy is firing on all four cylinders. Growth has been 6.9pc over the last year. It accelerated in June, with industrial output jumping to 7.6pc and retail sales rising 11pc.

This surge in growth is happening despite eight months of monetary tightening and lending curbs. What it shows is the unstoppable power of

‘China’s rising indebtedness has come to represent all that is disconcerting about their economy’

credit booms once they are under way. The PBOC is particularly worried about an array of asset management products (AMPS) issued by securities firms, funds and insurers. These are a key reason why Chinese banks have, in effect, built up exposure to assets equal to 650pc of GDP.

This is higher than the ratio in financial entrepots such as the Singapore, Switzerland, or the UK, and the vast volumes are levered off a thin capital base of 20pc of GDP. In theory, Chinese banks act as agents while buyers take on the risk. In reality, the public buy these instruments on the assumption that they will always be bailed out. This has become the Achilles’ heel of the Chinese financial system.

“If the banks’ implicit guarantee starts to unravel, households may rush to withdraw funds,” said Capital Economics. “This could snowball into a growing number of AMP defaults, since maturity mismatches mean that issuers often rely on new inflows to pay out maturing bonds. The impact on financial stability would be significant,” it added.

Jahangir Aziz and Haibin Zhu, from JP Morgan, said the debts of the stateowned entities (SOES) have alone reached 90pc of GDP or $13.3 trillion.

Nearly 60pc of new credit this year is being used to repay old loans. It takes four times as much new credit to generate a given amount of extra of GDP as it did a decade ago. “China’s rising indebtedness has come to represent all that is disconcerting about their economy,” they said in a report entitled “The Sum of All Fears”.

The credit-to-gdp gap tracked by the Bank for International Settlements is at 24pc, far above the level of 10pc that usually foretells a banking crisis

within three years. Most of the debt is domestic, the local savings rate is high, and foreign reserves are huge. All this offers some protection but JP Morgan argues that much the same was true of Japan before it slid into intractable slump.

The widespread assumption is that there cannot be a financial crisis in China’s closed state-controlled system, and that any denouement is more likely to be a slow loss of dynamism. Growth rates could fall to 2pc by the early 2020s.

Yet this could prove complacent. The shadow banking data released by the PBOC opens a window into something more disturbing. China may not see a classic “Minsky moment” like Lehman but there could be a traumatic ending nevertheless, with distinctly Chinese characteristics. This year at least looks safe.