As the economy rapidly grew in China, demand also grew for credit, especially to companies that cannot qualify for a bank loan. “A decade ago, conventional banks, which are almost all state-owned and tightly regulated, accounted for virtually all lending in China”, but this new demand let to a accelerating growth in shadow banking in China (Jing 2014). Shadow banking refers to “a ‘system of credit intermediation that involved entities and activities outside the regular banking system'” (Liu 2014). These involved trusts and leasing companies. Shadow banking is not inherently bad as many institutions supply investors high returns and provide loans to companies which usually would not qualify from a bank loan. the government was also hesitant to completely crack down on shadow banking because it helped support rapid economic growth. (Hsu 2015) However, problems arise because these institutions do not have to follow the same government regulation. For example, shadow banks do not have to carry as much capital as government regulated banks. (Elliott 2015) Shadow banks can also invest in over produced aspects of the economy, like steel and real estate, which regulated banks have been encouraged to slow down investment.
Source: http://www.economist.com
Recent problems with shadow banking has emerged as the housing bubble has begun to burst in recent years. Even as the government tries to crack down on shadow banks, like trusts, “money is flowing to other, less closely watched intermediaries. ‘Shadow banking in China looks like a cat-and-mouse game,’ declares Liu Yuhui, chief economist of GF Securities, a brokerage house” (Jing 2014). As economic growth is slowing, some trusts have defaulted. Furthermore, experts claim “a sharp downturn in some sectors could cause trouble for shadow banks, leading to a broader financial mess” (Jing 2014). A lot of China’s shadow banks have invested in real estate. Therefore, as the real estate bubble begins to burst, people are worried the effect is could have on the shadow banking industry and what effects it could have on the economy as a whole.
Works Cited
Hsu, Sara. “The Rise and Fall of Shadow Banking in China.” The Diplomat. Web. 15 Mar. 2016.
Jing, Jiang. “Battling the Darkness.” The Economist 10 May 2014. The Economist. Web. 15 Mar. 2016.
Lee, Justina. “China’s Shadow Banking Evolves to Dodge Crackdown.” Bloomberg.com. N.p., n.d. Web. 15 Mar. 2016.
Liu, Xiangmin. “Shadow Banking in China.” Banking & Finance Law Review 30.1 (2014): 127–135. Print.
China’s banks retain strong ties to the days of communism and central planning when heavy industry was the primary focus of the government. As a result only large companies have ready access to credit. Small and medium size companies are forced to raise capital in other ways. Some of this occurs through shadow banking. Individuals trying to start their own business usually raise funding through family and friends which can be seen in Hessler Part II. Banks are also reluctant to lend to small and medium enterprises due to China’s relatively high required reserve ratio of 20% compared to 10% in the U.S. and 1% in Europe.
https://risk.thomsonreuters.com/sites/default/files/GRC00715_0.pdf
Come now, even in the US small companies must be ready to self-finance! Lending to small businesses is skilled-labor-intensive, but the margins have to be kept modest because they do face competition from shadow banks. Furthermore, skilled bankers are scarce, and the infrastructure to support them is weak. If you don’t have good credit rating databases to track the history of not just small businesses but their owners and their other small businesses – if the owner himself or herself disappears, or can’t pay back loans to other businesses, then you’re unlikely to collect on your loan, either. In general disentangling that sort of situation is hard even in the US, but it’s impossible in China. So small businesses in China aren’t (or shouldn’t be!) bankable.
This seems like another example of decentralization amidst a clearly centralized government. Obviously, a communist government cannot have its hand in all local activities. This points to one of the phrases contained in Hessler: “The hills are high, the emperor far away.” As JT said above, small and medium sized companies cannot be approved for loans from “real” banks. And in a country in which the central government has little oversight in local areas, it’s no surprise that shadow banks have emerged to fulfill the demand for credit.
So the problem of shadow banking kind of remind me of the problem of food security. Both indicate a strong need for better regulation system. And speaking of regulation system, it has long been a very troublesome topic throughout Chinese history. Through our long history, I cannot think of one period that regulation system is satisfactory. I wonder if that has something to do with the national characteristic or with the large population.
To big banks going through a much slower growth than usual, shadow banking may seem like a good way to boost profits. In reality, this is not the case however. “Analysts say [shadow-banking products] could worsen [banks’] financial position should market conditions deteriorate,” reports Chuin-Wei Yap of the Wall Street Journal. Banks are looking for a way out of this comparative slump. With net profits down from 8% to 0.5% in one year, Industrial & Commercial Bank of China Ltd. is not doing as well as its executives would like. If there is a way to increase net profits to previous levels of 8%, those in charge are trying to find it. Will the risky investments in shadow banking pay off, or will the analysts prove correct in their predictions?
http://www.wsj.com/articles/chinese-banks-look-to-shadow-banking-for-growth-1446199671