In the wake of the 2008 financial crisis, shadow banking in the U.S. came to the forefront of financial concerns. The shadow banking industry represents a relatively unregulated credit creator in financial markets, and while governmental reforms in response to the financial crisis in the U.S. have attempted to address this issue and provide some oversight for these institutions, the shadow banking industry in China is now presenting similar concerns. As Gabriel Wildau puts it: “A financial system in which the government refuses to tolerate defaults has also encouraged moral hazard among investors by creating an expectation that even risky credit carries an implicit guarantee.”
An environment in which companies are increasingly desperate for funds, and bank lending is becoming less and less accessible, has opened the door for an expansion in shadow banking as China’s rapid economic expansion begins to slow down. Now, as investors look to pull their money out of these institutions, they can not pay out their annual interest rates of 14-18 percent. In terms of governmental oversight in China, no one agency claims responsibility for monitoring the shadow banking industry.
“‘If it’s a non-financial guarantee company then we have nothing to do with regulating it,’ said an official at the Shanxi Financial Affairs office, who declined to leave his name. He directed inquires to the Department of Commerce. An official at the department’s administrative office said his agency was not responsible for non-financial guarantee companies.” Investors continue to protest outside the closed doors of lending institutions such as Platinum Assemblage, in the hopes that large enough protests, coupled with police involvement, will force the government to provide some oversight into this corner of the financial market.
Source: Wildau, Gabriel. “China Shadow Bank Collapse Exposes Lending Risks.” CNBC. N.p., 03 Dec. 2014. Web. 28 Jan. 2015. <http://www.cnbc.com/id/102238059>.
Developing countries frequently engage in “financial repression”; China is no exception. In the name of facilitating investment, deposit interest rates are kept low, and at least some savers look to riskier assets to increase their return. On the flip side, low interest rates can spell excess demand for loans from financial institutions, such that small borrowers are shut out of the system. They too face may be willing to pay a higher price [= interest rate] in return for access to funds. In addition, financial institutions in China are still “young” with staff only gradually gaining experience and (potentially) weak credit controls and high costs. They will want to focus on the safest and easiest borrowers, not on ones whose risk is hard to evaluatie, who borrow in small amounts, and otherwise can be costly to service. Shadow banking can fill those gaps, but unregulated financial institutions are also more likely to engage in blatant fraud, hard enough to detect in the US (think Madoff) but even harder in China were there are few credit rating agencies or stock analysts, where corporate accounting can be creative (and entirely lacking in small firms), and where sharing information across players in markets can be impossible.
An example of the “blatant fraud” suggest by the Prof could have occurred very recently: multiple bank accounts owned by Trafigura, one of the three largest oil and metal traders, were closed. Apparently, the company stole $32,000,000 during a gasoline trade fraud.