Sara Hsu
Sara Hsu

China´s financial authorities try to fight illegal fundraising, as one of the features of shadow banking. Financial analyst Sara Hsu analyses in The Diplomat this tradition, that has boomed with the country´s economic growth.

Sara Hsu:

This type of illegal activity has only increased since, as China’s economy has grown. Over 2,000 cases have been addressed yearly since 2005, and 3,700 cases were handled in 2013 alone. In September 2013, an online investment website run by Hong Kong Jinyu Hengtong Investment Management Ltd was shut down after losing 10 billion RMB ($161 million) in investor money. The wealth management product the website offered promised a monthly return of 45 percent. Investors, with few other investment outlets, have often been lured by the shadow banking sector, which has promised far better returns than those on bank deposits, which are often negative once inflation is taken into account.

The shadow banking sector has been popular for that reason. The formal sector is constrained both in terms of the supply of funds to smaller and riskier entities, and in terms of returns to investors. Therefore the shadow banking sector has attracted many participants. The sector is diverse, ranging widely from curb lending to trust asset securitization, and it is difficult to monitor. Because shadow banking channels are so varied, financial criminals are able to seek out the least regulated areas in which to conduct their business. While some types of funds are used in an immoral fashion, such as in unproductive property developments, other funds are used for illegal purposes, such as for personal consumption. The more closely the user of illegal funds is aligned with the procurer of illegal funds, the more potential there is for legal repercussions to ensue…

The general rule of thumb in these cases may be that the less formal the type of fundraising carried out within the shadow banking sector, the more at risk it is of being pursued as an illegal fundraising case. Although fraudulent fundraising imposes enormous costs on the public, productive finance within these less formal channels should still be clearly differentiated from unproductive finance. This will allow smaller enterprises to continue to operate and bolster China’s large economy. Some liberalization of the banking sector would also be welcome, in the former of higher deposit rates and the extension of bank loans to small and medium sized enterprises. The more that can be gained by clearly legal means, the better off all economic participants will be.

More in the Diplomat.

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