The mystery of Chinese shadow banking

Courtesy of Also Sprach Analyst.

Shadow banking in China has been a growing problem since 2008. However, no one knows exactly how large it exactly is. Estimates usually put the size in the order of tens of trillion, but nobody can come up with an exact figure.

Not even Xiao Gang, the chairman of Bank of China, one of the Big 4 Chinese state-owned banks. He wrote recently in the China Daily that “wealth management products, underground finance and off-balance-sheet lending” may negatively impact credit flow. However, he also has no idea how large the whole WMPs and trusts things are:

Chinese banks work closely with trust companies or other entities by packaging trust loans into WMPs, offering investors a higher yield than conventional bank deposits can. These products are mainly sold by commercial banks either at their branches or online. Many of the funds that were obtained through these channels went into real estate development, infrastructure projects, the manufacturing sector and local government financing vehicles. Banks are playing the role of”middlemen” between the recipients and investors.

It is difficult to measure the precise amount and value of WMPs…

There are more than 20,000 WMPs in circulation, a dramatic increase from only a few hundred just five years ago. Given that the number is so big and hard to manage, China’s shadow banking sector has become a potential source of systemic financial risk over the next few years. Particularly worrisome is the quality and transparency of WMPs. Many assets underlying the products are dependent on some empty real estate property or long-term infrastructure,and are sometimes even linked to high-risk projects, which may find it impossible to generate sufficient cash flow to meet repayment obligations.

Moreover, many WMPs are not even linked to any specific asset, rather, just to a pool of assets, whose cash inflows may often not match the timing of scheduled WMP repayments.

China’s shadow banking is contributing to a growing liquidity risk in the financial markets. Most WMPs carry tenures of less than a year, with many being as short as weeks or even days.Thus in some cases short-term financing has been invested in long-term projects, and in such situations there is a possibility of a liquidity crisis being triggered if the markets were to be abruptly squeezed.

You can read the whole thing here.