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Exposing China's Mysterious Multi-Trillion Shadow Banking System

Tyler Durden's picture


Precisely a year ago, a summary report by Fitch shone the first, if relatively weak, light on the massive Chinese securitization industry which had for years allowed the country to fund its housing bubble without forcing the banks to actually take much if any of the loan risk associated with this unprecedented expansion. At the time of the Fitch report, the securitization discrepancy was not deemed to be excessive and at about RMB 1 trillion in annual issuance it was promptly swept under the rug. Nonetheless the key statement remained: "Fitch believes the vast majority of these transactions are not publicly disclosed by Chinese banks, and few, if any, traces of the loans remain in financial statements." More recently, and long overdue, Moody's took a refresh look at the same problem and on July 4 released a rather disturbing report which found "that the Chinese audit agency could be understating banks' exposures to local governments by as much as RMB 3.5 trillion." At 10% of GDP, the number sure is starting to get larger. Today we present what we believe is the most comprehensive report we have seen to date on the matter of the Chinese "Shadow Banking" industry courtesy of SocGen. For those who enjoy putting things into perspective, SocGen quantifies the total shadow banking system in China to be as large as RMB10 trillion (or 55%, of the Total Social Financing of RBM18 trillion): nearly USD1.5 trillion. While the number is not massive (considering that the most recent corresponding shadow banking number for the US is well higher at about $16 trillion), it keeps increasing as a portion of GDP. Why is this important? Because as SocGen's Wei Yao says, "The currently unsupervised development of the informal financing market delays the intended impact of monetary policy tightening, but adds to the risk of precipitating a liquidity crunch of the entire financial system later."

Yao adds: "However, we don’t think the solution lies in simply banning such channels. Instead, they should be brought into daylight and better regulated, as China badly needs to deepen its financial system beyond the big commercial banks." While we will not hold our breath on the regulation aspect, we are concerned by the implications of what shadow banking may imply for China's attempts to slow its economy via conventional means, especially since round after round of RRR and interest rate hikes have so far proven useless at slowing inflation which at last check was well over 6%. So it this Chinese shadow banking system a potential monetary time bomb, destabilizing the PBOC's efforts at normalization and adding materially to systemic risk? Read on.

From SocGen's Wei Yao:

China’s shadow banking system awaits sunlight

China’s formal bank lending has been under restraint since the People’s Bank of China stepped up quantitative tightening late last year. However, unregulated financing activity is sprouting up like weeds throughout China. Trillions of yuan in capital have been raised through investment trusts, underground money markets and high-yield retail investment products to sustain short-term liquidity for those who are cut off from the formal credit market, especially small- and medium- enterprises, private property developers, and more recently, local  government financing vehicles.

The currently unsupervised development of the informal financing market delays the intended impact of monetary policy tightening, but adds to the risk of precipitating a liquidity crunch of the entire financial system later. However, we don’t think the solution lies in simply banning such channels. Instead, they should be brought into daylight and better regulated, as China badly needs to deepen its financial system beyond the big commercial banks.

For starters, it is important to understand that China’s “shadow banking system” is much less sophisticated than that in the US. Although China has moved to open up its economy in order to honour its WTO commitments, its financial sector is still very much undeveloped, highly protected, and largely dominated by the big banks. The private sector remains underserved by regulated commercial banks and can only seek credit from unchartered channels. Yet, many operations of China’s shadow banking sector would not be regarded as shadow in other economies with more developed financial markets.

China’s shadow banking sector is growing fast but still lightweight.

As in the case with any shadow system, data related to China’s nonbanking financial entities are fuzzy. In order to better gauge China’s domestic liquidity conditions, the PBoC introduced a new measure called “total social financing” (TSF) this year, which is similar in concept to flow of funds data. The series adds up bank lending, entrusted loans, trust loans, bank acceptance bills, bond financing, and stock market share issuance.

According to the latest release, formal bank lending provided nearly 60% of the CNY 7.76trn TSF in H1 2011, with the bond market and equity market contributing another 12%. Trust loans extended by banks – a form of securitised bank loans – contracted 84.8% yoy due to the harsh curbs by the banking regulator since H2 2010; entrusted loans, which mostly went to finance private property developers, increased 120% yoy.

There is no doubt that the TSF series from the PBoC still omits a number of credit channels. Fitch Ratings has developed its own version of TSF, which adds letters of credit, credit from domestic trust companies, lending by other domestic nonbank financial institutions, and loans from Hong Kong banks. The agency estimates the adjusted TSF to reach CNY 18trn in 2011, which could be one-third more than PBoC’s reading. In that case, the formal banking sector’s share as a financing channel would drop to less than 45%. This would represent a significantly lower level than in previous years, but still strikingly high compared to the financing patterns in other economies.

If we look at the stock rather than the flow, the shadowy sector would appear even more lightweight. We estimate that China’s commercial banks’ share of total financial institutions’ assets are no less than 80%, vs. only 30% in the US.

The liquidity risk is rising.

Capital raised via shadow channels has largely gone to three types of companies – private small- and mediumsized enterprises (SMEs), private property developers, and local government financing vehicles (LGFVs).

SMEs have been underserved by China’s banking system for years, and the PBoC’s quantitative policy tightening pushes this structural problem to its extreme. The scale of this credit market is the most difficult to gauge. According to the PBoC branch in Wenzhou, China’s No.1 city of entrepreneurship, 16% of SME funding came from underground banks in Q1, which charged an average annual interest rate of 25%. However, numerous reports suggest that interest rates on working capital loans have reached exorbitant levels of 6~10% per month in some cases.

Property developers have been turned down by banks since the central government got serious about curbing property prices late last year. The interest rates charged range from 15% to 30% per annum. LGFVs are also forced to borrow at higher cost from these channels because of tighter regulation. Although the total exact volume is unclear, we think it should be a relatively small amount, as LGFVs still have the closest ties to local government and are able to negotiate debt restructuring with formal banks. The obvious risk with these two types of entities is the mismatch between the durations of short-term borrowing and long-term investment.

Borrowing at such high levels of interest rates in the shadow banking system is clearly not sustainable. Resilient domestic demand may support this operation, but those enterprises probably operate on the hope that currently tight liquidity conditions will not last long. The availability of alternative credit channels merely reinforces this hope and delays the impact of the PBoC’s tightening. Therefore, if the PBoC continues to keep a firm hand on credit growth, the Chinese economy could run into a systemic crunch.

Depositors are benefiting for the moment, but regulatory loopholes need to be addressed.

On the flip side, the average Chinese household has options to earn higher return than the 3.5% deposit rate and even above the inflation rate, via high-yield investment products (HYIPs). In this sense, this is a good development. While the Chinese government is moving painfully slowly towards deposit rate liberalisation, the competitive shadow banking system is test-bedding this idea. This is why we don’t think the solution should be a straightforward ban.

Initially, the HYIPs were just pools of fixed income securities packaged by commercial banks. In order to compete for household savings, more exotic and riskier assets were added to boost yields, including structured securities and even private equity investments. Yet investors are often not properly informed of the risks they are exposing themselves to. If losses occur on a large scale, it could quickly ignite social discontent in the currently delicate environment. In H1 2011, the commercial banks issued CNY 8.5trn of HYIPs, but the total outstanding amount is only CNY 2tn. This extraordinary high velocity indicates high vulnerability to changes in overall liquidity conditions.

Regulation and monitoring are needed. The banking regulator has begun to tackle this issue and ordered a suspension of six types of HYIPs with high risk ratings last week. This intervention is constructive, but also likely breaks some weak links in the system. The hope is to have continued good growth, while the government gradually tidies up the unregulated market. But what we have now is an unstable equilibrium.


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Tue, 07/19/2011 - 19:46 | 1472343 blindman
blindman's picture

i say holy fuck and haven't but read the title.

Tue, 07/19/2011 - 20:05 | 1472381 Mr Lennon Hendrix
Mr Lennon Hendrix's picture
China's Mysterious Multi-Trillion Shadow Banking System....bitchez!!!
Tue, 07/19/2011 - 20:35 | 1472464 Michael
Michael's picture

Does this mean China's 64 million empry vacant properties in inventory may become a problem?

Tue, 07/19/2011 - 22:59 | 1472788 Spitzer
Spitzer's picture

Read it, the title is misleading.

Its not that big of deal, seriously

Wed, 07/20/2011 - 05:14 | 1473020 Michael
Michael's picture

I think it's all because of the Ron Paul movement rebellion going on.

They used to call it The Ron Paul Revolution.

The goddamn Tea Party is threatening to filibuster with DeMint and Paul junior tag teaming to Filibuster, and the Senate knows there isn't a goddamn thing they can do about it.

Obama and the republicrats are going to throw them a bone to shut them up or everyone important gets nothing. NOTHING!

Tue, 07/19/2011 - 20:47 | 1472493 IQ 145
IQ 145's picture

 I like the quote in heavy print very much; because, it could be applied without change to the US. The un-supervised shadow banking operations in the US contributed significantly to the instability and the size and urgency of the corrective necessary when a fiscal crisis occured.

Tue, 07/19/2011 - 23:05 | 1472795 trav7777
trav7777's picture

why is it everyone points out the rampant fraud and bad loan problem in China, that you guys invariably say OH WELL THE US!!!!!

I mean, wtf, there's plenty of time to bash the fuckin US on all the other threads about the US banking system.  This article was about China's banking system which is even MORE chockfull of fraud and junk paper than the US's

Wed, 07/20/2011 - 03:12 | 1473016 Yen Cross
Yen Cross's picture

  That was a pretty decent point trav.   I suggest you study the opening of the PBoC bond market before you comment further.  +1 buy ( sp. intended) the way.   Yen

Wed, 07/20/2011 - 04:19 | 1473043 magpie
magpie's picture

i also enjoy the epic battle between price control and printing press.

Wed, 07/20/2011 - 04:27 | 1473046 Yen Cross
Yen Cross's picture

  You really mean {JUSTIFICATION} for more Debt Monetization!

Wed, 07/20/2011 - 04:34 | 1473049 Yen Cross
Yen Cross's picture

 These flippid d-double posts are odd.?

Wed, 07/20/2011 - 11:41 | 1473922 topshelfstuff
topshelfstuff's picture

""""why is it everyone points out the rampant fraud and bad loan problem in China, that you guys invariably say OH WELL THE US!!!!! """

many reasons: not much Trust in our so-called MSNews, typical to distract, typical to point first to another and accuse them of doing what you're doing. The post above yours, by IQ is suggesting the ol' "Pot calling the Kettle Black", here:

""" it could be applied without change to the US.""""

and I've seen this many times in an article where you could think it Fits the US

its been pretty standard now, and in the past approx. year, to point to China, and accuse them of being the cause of global problems

Its also kept out of our news how China. most all of Asia, and Latin America, has been Raising Wages by over 10% Yearly, keeping their People well ahead of Real Inflation. You can google each country and be astounded, though not a Peep about this here. Its also important to understand PPP Purchasing Power Parity. We only think of the Average Chinese Worker as a low-paid employee, yet these same People have a Savings Rate near 50%, so obviously we're shown a false "Picture"

Tue, 07/19/2011 - 21:19 | 1472571 blindman
blindman's picture

and now i have read the phrase
"unstable equilibrium".
this makes me feel slightly better
but still uneasy, such is life.
i live to be junked, work it.
stability, equilibrium, china, economics,
fraud, fiat, money, capitalism, communism,
command and control top down rule of law
acting as a person imitating a human being
for fun and profit, representative theft
and regulatory insolvency.
now what? don't just junk, learn to swear.
you can do it!!

Tue, 07/19/2011 - 19:53 | 1472361 Lord Welligton
Lord Welligton's picture

And the reason anyone should give a shite is what exactly?

Tue, 07/19/2011 - 20:21 | 1472434 Atomizer
Atomizer's picture

Don't bore us with your stupidity. Wealth was transferred from Britain to US. The next stage is to transfer wealth to China. Empires are bubbles in the eyes of Central Banking.

Tue, 07/19/2011 - 20:41 | 1472479 Lord Welligton
Lord Welligton's picture

Don't bore us with your stupidity

I'm far from stupid.

I'll ask you directly.

Why should anybody give a shite?

Tue, 07/19/2011 - 20:48 | 1472497 IQ 145
IQ 145's picture

 Who or what is Lord Welligton?

Tue, 07/19/2011 - 20:52 | 1472509 IQ 145
IQ 145's picture

Apparently, according to Google; Lord Welligton is someone who posts ignorant shite on blogs.

Wed, 07/20/2011 - 00:09 | 1472879 Vic Vinegar
Vic Vinegar's picture

And according to Zero Hedge you are a douche who expresses his insecurities via his userid.

Wed, 07/20/2011 - 00:34 | 1472915 Vic Vinegar
Vic Vinegar's picture

And before I log off (I love this site but do have better things to do now and then): what the fuck is with your misuse of the semicolon?  You are becoming a joke on this site, if you weren't already one.

Wed, 07/20/2011 - 03:35 | 1473022 ZeroPower
ZeroPower's picture

Cool story bro

Wed, 07/20/2011 - 03:08 | 1473013 Yen Cross
Yen Cross's picture

IQ 1.45 let's take some (Requiem) into account... You aren't dealing with Glass ceiling IVY huggers here. (dot)    yen...

Tue, 07/19/2011 - 20:33 | 1472453 Gohn Galt
Gohn Galt's picture

Why are you getting junked?  I love that old clip. 

Tyler I like hearing these perspectives.  I was sure the shadow banking system was much worse than that.  Definetly bullish.

This post was supposed to go as a response under Atomizer 1472371.  Would someone be so kind as let me know how I can delete or move a post?

Tue, 07/19/2011 - 23:56 | 1472868 Vlad Tepid
Vlad Tepid's picture

Edit and erase your text and repost.  Your blank text box will stand as a testament for all time to your (now immortal) flub.

Tue, 07/19/2011 - 19:58 | 1472371 Atomizer
Atomizer's picture

How Obama will figure your taxes by Progressive Math


IMF learns of new phone hack, 'Gang of Six' regroups.

Tue, 07/19/2011 - 20:11 | 1472402 S-hai High
S-hai High's picture

Interesting article - certainly true there are some hurdles that China needs to overcome. But, even the article states that China's problem is not even a dot relative to the U.S problem. The fact that China also consistently runs a trade surplus and has huge FX reserves will cushion what would otherwise be a painful lesson.

"Yet investors are often not properly informed of the risks they are exposing themselves to. If losses occur on a large scale, it could quickly ignite social discontent in the currently delicate environment"

Since over 95% of chinese really have no money and are happy to have a house and food, the number of people investing in such structures is absolutely tiny. It will hardly spark social discontent... rising prices for staple foods on the other hand...


Tue, 07/19/2011 - 23:09 | 1472799 trav7777
trav7777's picture

the article doesn't say that at ALL.  In fact, if you do ANY research into China you see that their problem DWARFS the US's.

WTF is with you people that you INSIST on bashing the USA for everything?  The Chinese are not fucking special; they are running a goddamned PONZI just like we are!

Wed, 07/20/2011 - 16:19 | 1475007 Herd Redirectio...
Herd Redirection Committee's picture

China has FX reserves??? Is he counting their US Treasuries at par, and thinks they are going to be worth anything 5 years from now?

As the saying goes, if I owe the bank $1million dollars, I have a problem.  If I owe the bank $1 billion dollars, the bank has a problem.  Thats what has happened with China.  They have lent so much to America that they stand to lose the most, by selling their Treasuries, holding them, or adding to their position!

Tue, 07/19/2011 - 20:19 | 1472419 carbonmutant
carbonmutant's picture

There is no doubt that the numbers are higher than reported BUT,

We're talking RMB here, not Dollars...

Tue, 07/19/2011 - 20:24 | 1472440 chump666
chump666's picture

China is an epic bubble which has a pending liquidity crisis mixed with inflation driven gray/black money + oil inflation =   Total disaster. Just hard to time the implosion.

The Apple 400 share hysteria is being underwritten by the CB cartels rhetoric mania.  Like the white knight (China) intervention, but it's good for like 48hrs...Then its sell again.

Tue, 07/19/2011 - 20:31 | 1472456 Justaman
Justaman's picture

What do you expect?  The Chinese learned from the biggest ponzi/shadow/insolvent banking system in the world!  The Chinese won't last as long as the ultimate fraudulent system, though.  


Tue, 07/19/2011 - 20:32 | 1472458 jo6pac
jo6pac's picture

So this means what? They're as fucked up as Amerika? I wonder if employee of the yr in China as in Greece is a gs person?

Tue, 07/19/2011 - 21:27 | 1472586 gwar5
gwar5's picture

We're all PIIGS.  Pigs get slaughtered.

Tue, 07/19/2011 - 21:30 | 1472593 max2205
max2205's picture

What if BK posted and no one commented

Tue, 07/19/2011 - 21:50 | 1472641 Atomizer
Atomizer's picture

Murdoch is being removed just as DSK was. Those special people (told you about), hiding in foliage will be springing out to protect the fraudulent system. Enjoy the comedy.

Wed, 07/20/2011 - 05:23 | 1473068 falak pema
falak pema's picture

Just on a lighter note read a history novel about the great big shooting match called the crusades; it will relax your jangled nerves and tell you how feudal lords settled their problems in the good ole days.

I am getting very ponzi myself as I wrote it. So hats off from a new Madoff in the making!



Tue, 07/19/2011 - 22:36 | 1472666 blindman
Tue, 07/19/2011 - 22:07 | 1472677 Itsalie
Itsalie's picture

"Therefore, if the PBoC continues to keep a firm hand on credit growth, the Chinese economy could run into a systemic crunch."

translated into layman lanuage:

"Print, PBoC, Print". Maybe less of such garbage from the bank who famously proclaimed "PIGS CAN FLY".

Tue, 07/19/2011 - 22:10 | 1472681 Man Bear Pig
Man Bear Pig's picture

is there a link to the report?

Tue, 07/19/2011 - 22:31 | 1472726 chump666
chump666's picture

Just saw a wire report on Roubini AUD fair value crapola...China bull?  Jeez Keynesian's still follow that Newton-ism determinism that chaos theory decimated 50yrs ago.  Meaning.  Shit happens internally then explodes externally...that's China baby



Tue, 07/19/2011 - 22:40 | 1472744 fraud-fed
fraud-fed's picture

How's that supposed to make us feel better, if we are already more than knee-deep?

Tue, 07/19/2011 - 23:05 | 1472737 kito
kito's picture

i second jim rogers on china. 

Tue, 07/19/2011 - 23:18 | 1472813 PulauHantu29
PulauHantu29's picture

In most of the larger cities the median house price is more then sixteen times the median income. The rule of thumb is more then 3x is unstable.

The coming year will be fascinating. My bet is their RE will "correct." Watch one of the tulloch interviews...he is a HK specialist on HK and China RE...


Wed, 07/20/2011 - 00:24 | 1472904 chump666
chump666's picture

yeah most traders should watch HK property, that goes first should spill over into China.  Tulloch is good, as is Faber re: HK property

Wed, 07/20/2011 - 11:09 | 1473763 qussl3
qussl3's picture

May pay to watch private property in singapore, volumes have collapsed yet prices continue to creep up, agents report all cash buyers from china holding it up.

WSeems like the marginal money has been driven there.

Wed, 07/20/2011 - 03:51 | 1473030 Yen Cross
Yen Cross's picture

  IQ 1.45 is a Sorite, with absolutely no concept of a YIELD CURVE!!!

Wed, 07/20/2011 - 03:54 | 1473032 steveo
steveo's picture

Euro dies First

I love things going down, of course that means something else is going up.

This Euro chart is amazing.

Wed, 07/20/2011 - 04:24 | 1473044 Yen Cross
Yen Cross's picture

  yes it is.  Trade smalls, or you will end up in the deep weeds. that is ,(unless) you know how to cloud trade?

Wed, 07/20/2011 - 03:57 | 1473035 steveo
steveo's picture

Euro dies First

I love things going down, of course that means something else is going up.

This Euro chart is amazing.

Wed, 07/20/2011 - 07:10 | 1473116 Silver Dreamer
Silver Dreamer's picture

It's not a problem.  If they run into economic problems, they can just send their army in to plunder.  Maybe China can find their own Libya, which was sitting on a horde of gold last time I checked.  Hmmm, I wonder how much gold Japan and Taiwan have...

Wed, 07/20/2011 - 10:00 | 1473499 Herkimer Jerkimer
Herkimer Jerkimer's picture

Thank you for your insights Mr. Durden on your web site. I am impressed, as always.

I'm wondering, as a financial newbie, if the Chinese banks have been doing what the American banks did, bundling up all this debt and selling it foreign investors, like the derviatives scam that caused the great calamity?

I sure hope not.

But I'm going to be betting that until I hear different, I'm thinking they are doing exactly that.

Gets them off the hook, too.


Herkimer Jerkimer



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