'Shadow Banking' In China

Tyler Durden's picture

authored by James Parker, originally posted at The Diplomat,

Xiao Gang, Chairman of the Bank of China (one of the “big 4” banks the Chinese government controlls), published an interesting op-ed in China Daily on October 12th.  Although some may consider the China Daily the English-language mouth piece of the Chinese government, its op-ed columns often hold some genuinely interesting discussions and analysis of events and affairs in China.

In this op-ed, Xiao Gang takes on the issue of “shadow banking,” that hazy and complicated area of finance that in the developed economies is often associated with hedge funds. As discussed in greater detail below, things are slightly different in China itself.

Chinese finance is undergoing dramatic changes which are not yet widely understood. Historically (mainly before 2008), the vast majority of lending in China was done by the normal banking sector in the form of loans.  The process was a cornerstone of the government’s control over the economy.  The vast majority of banks in China are controlled by the government, so the “who and when” of lending was firmly in the hands of China’s leaders.

The years 2008/9 will be remembered as watershed years for Chinese finance. The financial crisis rippling out from the United States caused a dramatic reaction by China’s policymakers as exports collapsed.  Two key trends developed.

The first is fairly obvious; a wave of credit was unleashed and has continued since that time as China’s growth became more and more reliant on investment and the lending needed to support it.  This exacerbated the fears that an unbalanced Chinese economy is undergoing an unsustainable build-up of debt, much like Japan’s did during its boom years.

The second trend came later and is much harder to pin down. In late 2009 and 2010, as policymakers began to worry about the credit boom, inflation, a property bubble, and overcapacity, they attempted to put a brake on lending activities.  The reduction in formal lending forced an economy addicted to credit to increasingly turn to less usual financing channels – some of them in the “shadow banking” sector.  This trend really began taking off near the end of 2009 and has generally increased ever since. The latest data (September 2012) shows that these non-normal bank credit channels now account for a substantial amount of the financing going on in the economy.

Taking these two trends together – an economy relying increasingly on debt creation for growth, and that debt creation becoming more and more complicated and obscure, it is easy to see why so many officials and analysts are worried. 

Formal banks are key players in the “shadow banking” system, helping to create, fund and market wealth management products to their customers – products which are riskier than deposits but which potentially pay a healthier return to investors.  Their goals are obvious, if credit taps are shut off, many borrowers who are not able to repay loans will default, hitting the banks’ formal loan books hard. Hence the shadow and formal banking systems have become intertwined, and the transmission of problems from one to another, or a negative feedback loop between the two, are not hard to imagine.

As Mr. Xiao bravely states in his column, it is paramount that the government increases its regulation of the “shadow banking” sector. The difficulty is that shadow banking is just one of the main economic dilemmas facing China at present: Is an economic rebalancing necessary? Is pushing through an economic rebalancing worth than pain of slower growth?

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no taste's picture

Shin Dong-hyuk born a slave in North Korea and who escaped via China is far more deserving of a Nobel Peace Prize than Obummer or Kissinger or the EU, but then so is my dog.


LongSoupLine's picture

hmmm, where have we heard of this type of banking before?...


oh yeah...bear, wamu, lehman, bac...

nmewn's picture

For reals.

When Mao's visionary elitist totalitarian communist state is corrupted by the elitist Keynesian-Krugman brand of socio-economic justice of just print more credit baby print, then truly...the end times are upon us...lol.

FreedomGuy's picture

Exactly! I have thought the same thing. However, Keynes appeals to central planners. In the end, the Chinese economic neophytes will find they have been once again fooled by the Western devils. The final phase will be when you see someone from Goldman Sachs in a position of power, at least in a consultant/advisory role.

nmewn's picture

Its an incredible thing to watch...human nature is the same world wide...imminently corruptable.

Politburo members living in lake/ocean side villas as villagers chase rats away from the dinner table and crony capitalists doing the same thing from Europe to the Americas.

Nothing changes, only the language used for "shooo, go away rats" ;-)

Robslob's picture

I will take
"When did Goldman (We do God's Work) and Jamie (I should of caught that) Dimon's firms open major offices in China for $1 Quadrillion Alex!

Daily Double!!!!

Mr. Hudson's picture

Confucius say: "shadow banking means counterfeit machine hidden in basement”.

FreedomGuy's picture

Control. Control! CONTROL! Yeah, that is the real goal of any state whether Washington or Beijing. It is the illusion or lie that more control leads to better results. And the sheeples, white or yellow will believe it for a variety of reasons. A few hundred years from now we will hopefully be disabused of these ideas.

ebworthen's picture

Sounds like the U.S.S.A.

East and West copying each other in the worst ways.

Urban Redneck's picture

The Chinese seem to have more of taste for equity and raw materials/durable goods than their US counterparts, where prefer debt and & iCrap

Ghordius's picture

+1 though don't forget the Chinese are at the moment mightily preoccupied with their factional political differences and time is running short for them to lay them down until the new cadre is announced

on a different note but related note the Austrians just banned their insurers from originating CDSs. under existing, revisited law

Urban Redneck's picture

I am waiting for Jiang Zemin to have a hot tub incident. This intergenerational puppet show in China is almost as bad as as everyone here waiting for 6 November, but over there isn't doesn't end with the conclusion of the Party Congress as long as the Old Hands continue pulling the strings.

Good to hear the Austrians figured out the State already has enough authority to execute needed regulation without writing new additional laws (until the State figures out how to abuse that privilege).

BlueCollaredOne's picture

Chinese banking system regitimacy makes me ror.

Buy this beel if you can.


Pure Evil's picture

Well, at least the Chinese don't have a ZH equivalent pointing out the obvious flaws of central banking.

The Bank of China can print with abandon and suffer no political fallout.

Krugman's and Bernanke's wet dream come true.

Three cheers for QEternity.

steve from virginia's picture



First of all, every single industrial enterprise since the beginning of time is debt-reliant. Firms need debt in order to be born. They need debt to keep the doors open, the firms' owners need the debt so they can get rich QUICK!


Warren Buffett didn't make US$55bn selling egg-beaters. He borrowed it, all of it. YOU SUCKERS have to repay the lender(s).


No debt = no fortunes. Why do you think the world's establishments are so eager to keep their countries' finance systems afloat at any and all costs? A: to preserve and 'make money-good' the fortunes of 'entrepreneurs' and 'innovators' (who should be boiled in oil, instead).


Part of China's credit-seeking operation is an artificially depreciated currency. To gain a trade advantage is to borrow from the accounts of citizens in other countries cheaply, without them even being aware of it ... more fortunes for entrepreneurs. However, the Chinese are accused of being currency manipulators so an effort has be made to convince the West that the Chinese are going to let the yuan appreciate.


Meanwhile, Chinese exporters are flooded with dollars and euros. Ordinarily these firms would swap these for yuan at the fixed rate.


Instead, the firms began selling dollars and euros on the street at a premium to the official rate. Soon, the yuan/dollar rate was much higher in back alleys than in Shanghai banking offices. China could have its cake and eat it too: a rising yuan in the official market and a sharply depreciated yuan elsewhere. Exporters could get a better price for any foreign currency than they could from the central bank. Yuan would then be lent at high cost to greedy suckers using the funds to build monstrous, empty concrete towers.


Everything worked: black market funds could return 120% (which paid the F/X cost), bought-and-paid-for government lackeys would use bank loans to retire the black market loans. Lots of towers got built and dollars were available for kleptocrats to steal ... and remove to Singapore, Hong Kong or elsewhere.


Sadly, the game is up: 180% interest is a bridge too far. The informal lending scheme is collapsing under its own weight. There are too many ugly concrete towers, not enough Chinese with cash to buy them. The bosses are fleeing with whatever dollars they can get their hands on. US finance is offering loans not currency flows. Dollars are in demand and becoming harder to find. The consequence is the popping tower 'bubble' and unsupportable loan balances. If the govt steps in to bail out black market borrowers it might have to answer some embarrassing questions. The alternative is an out-and-out collapse.


Deflation means the yuan will become harder and will appreciate. This will smash the Chinese export industries. It might be a good forex trade, like the Swissie ... both have the same problem ... caught up in their own false narratives.

williambanzai7's picture

Shadow banking is loan sharking, an activity that is nothing new in this part of the world.

Apparently the vast majority of personal consumer loans used for mainland Chinese luxury spend are obtained via this channel. There is even an initiative to somehow legitimatize it via integration into the finance sector.

However, the vast majority of luxury goods are purchased as business gifts.

falak pema's picture

...The difficulty is that shadow banking is just one of the main economic dilemmas facing China at present: Is an economic rebalancing necessary? Is pushing through an economic rebalancing worth than pain of slower growth?...

The Chinese learn fast, in the context of crony "globalisation", the phony ways of the west, its steroid fed beanstalk of genetically modified funny money. We are all riding the favorite "hobby horse" of the current runaway capitalist Zeitgeist. Draghi and Bernanke fabrication perfumed fiat of Chanel #5 essence; like its iconic image, the Brad Pitt profile now ex-fight club more new nite-club! 

What globalisation has done best is to make the whole world a cesspool of shadow banking and Mafia white washed money tanking; Macau and Las Vegas culture of the happy few. 

Tipping times and deleveraging chimes; the Oligarchy world has to prepare to pay this awesome bill sometime down the road. The later the better is what they sing in the CIty and WS; as they merrily merrily pay their political cronies in millions of dollars for their Presidential hit-parade.

But in the meantime First world Rome will burn as will the Roman satrapies; like Syria/Libya of oil patch Pax Americana Middle Kingdom today.

The weak link as always in any great game is the horseshoe of messenger that gets the blame for battle lost and kingdom destroyed. 

17 trilions* is the current Oligarchy stake and HFt mania  the current way to bake this putrid cake.

* http://www.bertelsmann-stiftung.de/cps/rde/xbcr/SID-D926D279-16A0E0E8/bst_engl/xcms_bst_dms_36654__2.pdf

Papasmurf's picture

The long arms of the squid....