Speculative investments in shadow banking are raising concerns for a economic slowdown in China, writes financial expert Sara Hsu in The Diplomat. She pleads for dealing with shadow banking in stead of monetary tightening.
There is growing concern that China’s economy may face a slowdown because of speculative investments in local government financing vehicles and real estate. This type of crisis would mirror that which occurred in the U.S. in 2007-2008, with asset price declines in real estate leading to liquidity and solvency issues in overleveraged financial institutions, triggering a financial crisis. Although China’s financial leverage ratios are not as high as those in the U.S. preceding the crisis, and the Chinese government is often considered a backstop for the loan operations of the banking system, there is still good reason for this concern…
China financial scholars are eminently aware that something grim lies ahead and many are hopeful that reforms to be pushed through by President Xi Jinping and Premier Li Keqiang will resolve some of the negative financial outlook. However, even if the financial sector is reined in, it seems the only way to really overcome this unstable “speculative spread” is to specifically target the shadow banking sector and curb its activity. It has been noted that monetary tightening will lead to a slowdown in credit growth and GDP, but it may not have the effect of curbing the shadow banking sector compared to less risky financial activity, and could even exacerbate the speculative spread.
Therefore policy aimed directly at the shadow banking sector is a far better idea: it could eliminate the threat of financial instability at its root. Reducing the risk of loans extended by trusts, or through banks as entrusted loans, and curbing the issuance of bankers’ acceptance bills can rein in the growing speculation and help to balance China’s financial sector as it is further reformed. As the financial sector is gradually liberalized and developed, the financial sector may be able to better handle the creation of non-standard debt assets.
Right now, however, this is something that should not be overlooked and presents a real threat to the Chinese economy. As sexy as it is to study illicit financial flows—particularly for those who profit from them—China watchers are right in fearing the intangible financial instability inherent in China’s current composition of financial flows.