Sara Hsu
Sara Hsu

Shadow banking seemed for a short while on the decline, but the industry is back in force, writes financial analyst Sara Hsu in the Diplomat. The recent rally of China´s stock markets was caused by shadow banking.

Sara Hsu:

Shadow banking experienced declines last year, as fewer funds were channeled to the property market via trust and wealth management products. Some of the funds that entered the shadow banking industry in search of yield were reoriented to the climbing stock market and recently, perhaps ironically, channeled to the stock market through shadow banking products. Fewer funds went into trust and entrusted loans during mid-year 2014, but this trend reversed in December 2014 as the shadow banking industry took advantage of the stock surge by promoting assets that included both stocks and more shadowy products such as trust and entrusted loans.

A recent crackdown on margin regulation has also served to induce investors to use wealth management products to purchase stocks through shadow banking channels. Although margin trading rose through 2014, the China Securities Regulatory Commission (CSRC) on January 16 reiterated that the minimum account threshold for opening an account (to be potentially used in margin trading) was 500,000 RMB ($80,000). In addition, the CSRC banned Citic Securities, Haitong Securities, and Guotai Junan Securities from opening new margin accounts for three months. Funds have increasingly been transferred to the stock market via umbrella trusts, which use both wealth management product proceeds and private investors’ funds. Private investors can make a profit on such assets as long as the stock market rallies.

In China’s relatively shallow financial markets, increasingly sophisticated investors have eagerly sought higher returns. The shadow banking sector provided such returns through mid-2014, lost its luster through November 2014 as the stock market rose, and rebounded in December 2014 in tandem with a stock market surge.

The bull market for stocks reveals that investors continue to hunt for yield, and equally importantly, that investors have a positive market outlook. This perspective reflects statements made by the leadership that the economic slowdown is not a product of declining prowess, but of restructuring toward a more advanced economy. It indicates belief in the ability of the leadership to restart the economy going forward. Although some analysts have viewed the stock rally as a byproduct of irrational investors, recent research by Ya, Ma and He (2014) has shown that China’s stock market increasingly reflects fundamentals and is not as driven by herding activity as in the past.

While the stock upswing reflects positive investor sentiments, regulators are wary of overleveraging in the stock market as they have been in the shadow banking market. Excessive undertaking of debt for investment purposes led to high leverage for margin trading, thus inciting the recent crackdown. Stop-loss positions for stock investment via wealth management products may exacerbate a stock downturn when it occurs. Continued monitoring by authorities will help to curb the worst practices and control the feeding frenzy in China’s stock markets as bullish investors pour funds into this “new” old financial channel.

More in the Diplomat

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