While China’s banking system has changed drastically over the past 20 years, one fact has remained: Chinese banks remain under the control of the government.
Some of China’s largest state-controlled commercial banks are the Bank of China, the China Construction Bank, the Industrial and Commercial Bank of China and the Agricultural Bank of China. But one recent issue facing the Chinese banking industry pertains to shadow banking, which refers to financial intermediaries that create credit across the global financial system but are not subject to normal regulations. Shadow banks function similarly to traditional banks, except that they can evade the regulatory constraints that state-owned banks are subjected to; however, they are not privy to some of the benefits that traditional banks receive, including publicly guaranteed deposit insurance or lender of last resort facilities from central banks.
For private businesses and entrepreneurs, shadow banks provide a simpler and expedited avenue to loans. However, for the layperson looking to invest, engaging with a shadow bank often means little to no knowledge of the investment vehicle being used. Wealth management products are sold by banks to Chinese investors “with the promise of interest rates much higher than what banks offer for deposits.” However, while traditional Chinese banks sell some or few wealth management vehicles, shadow banks tend to rely on them. Additionally, shadow banking activities are practically off the books, allowing the lenders to evade regulation.
Chen Wenhui, the vice chairman of the China Insurance Regulatory Commission, said that shadow banks offer large returns at proportionally low prices, which attracts laypeople despite not knowing how their money will be invested.
Another form of shadow lending in China is entrusted loans, which are loans from one company to another. These transactions are often conducted through a third-party bank to evade Chinese regulations on companies lending directly to each other. While leaders in this space believe that the risks associated with entrusted loans are manageable, regulatory agencies are skeptical of the methods shadow banks use to raise the money they lend.
Yi Huiman, the chairman of the Industrial and Commercial Bank of China, has taken stark opposition to shadow banking, stating, “If we do not deal correctly with shadow banking, the risks could be huge.” Additionally, Yi noted that shadow banks have given way to “higher leverage, too many derivatives and too many products with no transparency.”