For some time shadow banking emerged in China as a potentially dangerous tumor on its financial system, but seemed to have faded away when the real estate crisis hit the country. Financial analyst Sara Hsu has a thorough look at the current state of the industry in the Diplomat. Is shadow banking dead?
Since shadow banking was generally not viewed as a cause of China’s economic decline per se, and especially since it was barely visible during the stock market boom, additional regulation imposed on shadow banking has been insufficient. While a couple of regulations were introduced, including a notice issued in the end of 2013, which clarified the scope of shadow banking, as well as some initial shadow banking provisions, a draft rule that encouraged banks to directly invest funds from wealth management products in December 2014, Circular 127, which restricted loans to enterprises disguised as interbank lending in May 2014, and 10 principles produced by the China Securities Regulatory Commission in September 2014 to regulate P2P, there were no regulations imposed that truly quashed the spirit of the shadow banking business. In fact, shadow banking entities expanded in some directions despite the slowing economy; insurance and securities companies increased their holdings of trust products, while crowdfunding, a new type of financing that allowed smaller investors to purchase shares in risky property developments, has become increasingly popular.
As a result, the sector was neither eradicated nor scapegoated. This is quite the opposite of what occurred in the United States during the global crisis, when the financial sector was blamed for the economic slowdown. The story was different, since the slowdown in the U.S. was the result of financial failure and was not engineered. In China, the story was that the economic slowdown was necessary, and from a radical standpoint even intentional. While focus shifted to overall economic growth, the nature of shadow banking changed but the sector did not disappear. As a result of tight money and distress in the real estate sector, new financing from trust loans and bankers’ acceptance bills declined in the second half of 2014, but additional flows to entrusted loans (as well as flows to corporate bonds and equity) were positive. Later, funds also flowed to umbrella trusts and P2P lending companies for investment in the stock market.
What is clear is that China’s shadow banking system has been associated with government control and political will, far more so than in the U.S. and Europe. If the Chinese government had wished to fully eradicate shadow banking at any point, it could have easily done so through regulation and directives. Yet the sector was and has been allowed to survive, taking on different forms that reflect existing economic and political conditions. This situation runs parallel to the more explicit relationship between banks and the government. Banks continue to reflect, to some degree, government objectives and the overall economic climate, focusing lending on particular sectors or entities. In fact, stimulus measures were carried out by directly injecting funds into large banks for loans to earmarked sectors. Therefore China’s shadow banking sector is unique to its political economy.
Still, shadow banking has become the catch-all for non-mainstream, more market-based, and riskier finance in China. While China’s shadow banking system was only lightly chastened by the most recent downturn, it should not be taken for granted that shadow banking has effectively considered risk. This is an area that needs constant attention if the nation’s financial system is to compliment, rather than curse, China’s growing economy.
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