China's "Credit Mystery" Deepens, As Moody's Warns On Shadow Financing

Tyler Durden's picture

Last month, we took a detailed look at what we said could be a multi-trillion yuan black swan. 

In short, one of China’s many spinning plates is the country’s vast shadow banking complex which allowed local governments to skirt borrowing restrictions leading directly to the accumulation of debt that totals some 35% of GDP and which has channeled trillions into speculative investments via the proliferation of maturity mismatched wealth management products. 

One of the problems with the system is that it allows Chinese banks to obscure credit risk.

As Fitch noted earlier this year, some 40% of credit exposure is effectively carried off balance sheet in China’s banking sector, making it virtually impossible to assess the extent to which banks are exposed. When considered in combination with the unofficial policy whereby the PBoC forces lenders to roll bad debt thus artificially suppressing NPLs, a picture emerges of a system that’s decidedly opaque. Here’s what we said back in May:

The percentage of  loans which are not yet classified as non-performing but which are nonetheless doubtful is much higher than the headline NPL figure and in fact, [Fitch] seems to suggest that some Chinese banks (notably the largest lenders) may be under-reporting their special mention loans. But ultimately it’s irrelevant because between bad assets that are ultimately transferred to AMCs, loans that are channeled through non-bank financial institutions and carried as “investments classified as receivables”, and off-balance sheet financing, nearly 40% of credit risk is carried outside of traditional loans, rendering official NPL data essentially meaningless in terms of assessing the severity of the problem.

Well don’t look now, but according to Moody’s, the practice of obscuring credit risk using one or more of the methods delineated above and outlined in these pages on any number of occasions looks to be getting worse. Here’s Bloomberg:

China’s riskier banks are investing more customer funds in financing that is kept off their loan books, making it harder for rating companies to gauge their asset quality.


There has been a surge in a balance-sheet item known as receivables, which often includes shadow funding such as trusts and wealth products, said Moody’s Investors Service. Fitch Ratings said it is hard to analyze this escalation in activity. Listed banks excluding the Big Four saw short-term investments and other assets -- which include receivables -- jump 25 percent in the first half, compared with total asset growth of 12 percent, data compiled by Bloomberg show.


Slower growth in the world’s second-largest economy coupled with "still significant" credit expansion prompted Standard & Poor’s to cut its view of the banking industry’s economic risk to negative from stable this week. Shadow-finance assets, estimated at 41 trillion yuan ($6.4 trillion) by Moody’s at the end of 2014, have become more attractive as five interest-rate cuts by the central bank since November curbed profits from lending.


"Our concern with some of these investment positions is banks are using them as a way to bypass lending restrictions," said Grace Wu, a senior director at Fitch in Hong Kong. "Unlike bank loans, they don’t get reported into loan provisions, so it’s more difficult for us to ascertain the asset quality."



The nation’s shadow-banking industry emerged as a way for creditors to circumvent lending restrictions and for savers to attain yields higher than the legally capped deposit rate. It includes trusts, asset-management plans and wealth-management products, which package loans into products for buyers.


Shanghai Pudong Development Bank Co.’s receivables made up about a quarter of assets as of June 30, according to its semi-annual financial statement. Out of 1.1 trillion yuan of receivables, 82 percent were trusts and asset-management plans that purchase trust loans, while 11 percent were other lenders’ wealth management products.


The receivables climbed in the first half because the bank invested more in other lenders’ guaranteed WMPs as well as in asset-management products derived from bills issued by large banks, Shanghai Pudong said in an e-mail. It added that its credit and liquidity risks are both manageable.

Make no mistake, assessing the risk posed by China's shadow banking system is famously difficult and has confounded more than a few analysts and commentators, but the simple, one-line takeaway here is that NPLs at Chinese banks are likely to be orders of magnitude greater than the headline figures and indeed, we suggested as much more than two years ago:

China is preparing to admit that the level of problem Local Government Financing Vehicle debt is double what was first reported just two years ago, something many suspected but few dared to voice in the open. But not only that: since the likely level of Non-Performing Loans (i.e., bad debt) within the LGFV universe has long been suspected to be in 30% range, a doubling of the official figure will also mean a doubling of the bad debt notional up to a stunning and nosebleeding-inducing $1 trillion, or roughly 15% of China's goal-seeked GDP! We wish the local banks the best of luck as they scramble to find the hundreds of billions in capital to fill what is about to emerge as the biggest non-Lehman solvency hole in financial history (without the benefit of a Federal Reserve bailout that is). 

And while the consequences of a banking sector implosion are hard to assess, the fallout from social upheaval is even more indeterminate. We bring that up because as we saw last month with Shan Jiuliang head of Fanya Metals Exchange, when WMP investors suspect they may have been misled about the safety of their investment, things can go south rather quickly and what the above suggests is that far from scaling back their use of shadow conduits, at least some mid-tier banks are dramatically increasing their exposure. 

For those interested, we've included our full review of Chinese WMPs below.

*  *  *

"Wealth management products in China have come under the spotlight after a series of missed payments raised concerns over the shadow banking sector that often directs credit to firms shut out from bank lending or capital markets," Reuters said in February, after reporting that CITIC (China's top brokerage), was looking at ways to repay investors after the issuer of one of the wealth management products the broker sold missed a $1.12 million payment to investors.

That news came a little over a year after the now infamous "Credit Equals Gold #1 Collective Trust Product" incident and a subsequent default scare on a similar product backed by loans to a struggling coal company. 

Although wealth management products and CTPs (which differ from WMPs) are often described as "murky" and "opaque", the basic concept is fairly simple. WMPs are marketed to investors as a way to get more bang for their buck (er.. yuan) than they would with bank deposits. Funds from these investors are then invested at a higher rate. If the assets investors' money is used to fund run into trouble, that's not good news for WMP investors. Simple. 

The main issue here is the sheer size of the market. As FT notes, "in 2010, as regulators tried to rein in the explosion in bank credit resulting from the country’s Rmb4tn economic stimulus plan, banks turned to trusts to help them comply with lending controls." So essentially, trusts helped banks offload credit risk at the behest of the PBoC. Here’s the process whereby banks use trusts to get balance sheet relief:

The amount of trust loans outstanding in China has ballooned to nearly CNY7 trillion (total trust assets under management is something like CNY14 trillion) and now, Hebei Financing Investment Guarantee Group - which, as Caixan notes, is "the largest loan guarantee company in the northern province of Hebei [and] is wholly owned by the provincial regulator of state-owned assets" - is apparently broke, and that’s bad news because it guaranteed some CNY50 billion in loans made by dozens of trusts who in turn issued wealth management products to investors. 

In short, if Hebei can’t guarantee the loans, WMP investors could be forced to take a loss and as anyone who follows developments in China’s financial markets knows, Beijing is not particularly keen on permitting SOEs to collapse - especially if there’s a risk of rattling retail investors’ fragile psyche. Here’s FT with the story:

Eleven shadow banks have written an open letter to the top Communist party official in northern China’s Hebei province asking for a bailout that would enable the bankrupt credit guarantee company to continue to backstop loans to borrowers. If the guarantor cannot pay, it could spark defaults on at least 24 high-yielding wealth management products (WMPs).


Hebei Financing Investment Guarantee Group has guaranteed Rmb50bn ($7.8bn) in loans from nearly 50 financial institutions, according to Caixin, a respected financial magazine. More than half of this total is from non-bank lenders, mainly trust companies, who lent to property developers and factories in overcapacity industries 


The letter appeals directly to the government’s concern about social stability and the fear of retail investors protesting the loss of “blood and sweat money”. The 11 companies sold 24 separate WMPs worth Rmb5.5bn.


“The domino effect from the successive and intersecting defaults of these trust products involves a multitude of financial institutions, an immense amount of money, and wide-ranging public interests,” 10 trust companies and a fund manager wrote to Zhao Kezhi, Hebei party secretary.


“In order to prevent this incident from inciting panic among common people and creating an unnecessary social influence, we represent more than a thousand investors, more than a thousand families, in asking for a resolution.”


Hebei Financing stopped paying out on all loan guarantees in January, when its chairman was replaced and another state-owned group was appointed as custodian.


Though Hebei Financing guaranteed loans underlying WMPs, the products themselves did not guarantee investors against losses. Caixin reported that several trust companies, fearing reputational damage, have used their own capital to repay investors. 


The 11 groups behind the recent letter have taken a different approach, pressuring the government for a rescue.

There a few things to note here. First, the reason the underling assets are going bad is because WMP investors' money was funneled into real estate development and all manner of other parts of the economy which are now struggling mightily. Second, the idea that China should allow for defaults on trust products is nothing new. In fact, we've been saying just that for at least a year. Finally, and perhaps most importantly, the banks' playing of the social instability card underscores an argument we made when China's equity market was in the midst of its harrowing plunge last month. In "Why China's Stock Collapse Could Lead To Revolution" we warned that "it is only a matter of time before all the 'nouveau riche' farmers and grandparents see all their paper profits wiped out and hopefully go silently into that good night without starting mass riots or a revolution."

Yes, "hopefully", but maybe not because as is becoming increasingly clear by the day, simultaneously micro managing the stock market, the FX market, the command economy, the media, and just about every other corner of society is becoming a task too tall even for the Politburo and sooner or later, something is going to break and shatter the "everything is under control" narrative.

Whether or not the catalyst for widespread social upheaval will be a catastrophic chain reaction in the shadow banking system we can't say for sure, but as FT reminds us, technical defaults on trust products have in the past been met with "public protests by angry investors at bank branches."

Here's a snapshot of WMP issuance (note the durations as it gives you an idea of what kind volume we're talking about on maturing products):

As you might have noticed from the above, it appears that maturity mismatch could be a real problem here. Here's what the RBA had to say about this in a bulletin dated June of this year:

A key risk of unguaranteed bank WMPs is the maturity mismatch between most WMPs sold to investors and the assets they ultimately fund. Many WMPs are, at least partly, invested in illiquid assets with maturities in excess of one year, while the products themselves tend to have much shorter maturities; around 60 per cent of WMPs issued have a maturity of less than three months (Graph 5). A maturity mismatch between longer-term assets and shorter-term liabilities is typical for banks’ balance sheets, and they are accustomed to managing this. However, in the case of WMPs, the maturity mismatch exists for each individual and legally separate product, as the entire funding source for a particular WMP matures in one day. This results in considerable rollover risk. 


In other words, the WMP issuers are perpetually borrowing short to lend long. The degree to which this is the case apparently varies depending what type of WMP (or trust product) one is looking at, and we will mercifully spare you the breakdown of the market by type (other than to include the pie chart shown below), but the important thing to note here is that it seems highly likely that at least CNY8 trillion in WMPs are exposed to the "considerable rollover risk" mentioned above.

Allow us to explain how this could end. If China allows a state-run guarantor like Hebei Financing Investment Guarantee Group (the subject of the FT article cited above) to go broke and that in turn triggers losses for investors in WMP products, demand for those WMPs will dry up - and right quick. If that happens, WMPs will stop rolling, freezing the market and triggering a cascade of forced liquidations of the underlying (likely illiquid) assets. 

It's either that, or China bails everyone out. As the RBA concludes, "a key issue is whether the presumption of implicit guarantees is upheld or the authorities allow failing WMPs to default and investors to experience losses arising from these products."

And while that is certainly a key issue, the key issue is what those investors will do next.

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Zirpedge's picture

Credit risk, Schmedit risk, we just add some zeroes to the balance sheet.



aint no fortunate son's picture

chump change, those guys know what they're doing, sounds like conservative asset management to me... what could possibly go wrong?

Charles Wilson's picture

Wow, that second graph looks kinda like an American flag, sorta upside-down, on acid...


Just sayin'...



Dead Canary's picture

Thank you for your rich and insightful analysis.

This blog has gone entirely too silly.

Mark Urbo's picture

China is a joke


Anymore who bought into this concept of the red dragon taking over the world is an idiot.  They are a total facade and they will collapse under their commie socialist system just as sure as it happens every time in history.

Ban KKiller's picture

"Wealth management products"....THANK YOU FOR THE LAUGH OF THE DAY. 


 "a key issue is whether the presumption of implicit guarantees is upheld or the authorities allow failing WMPs to default and investors to experience losses arising from these products."     YEAH, sure, bet the farm on it! What, they have? Oh. 

headhunt's picture

Looks a lot like the US derivatives in housing several years back.

I would go all in.

falak pema's picture

You mean for ONCE Moody's is playing at HONEST sheRLOCK ?

Man, they must be smoking another pipe than their normal one!

Consuelo's picture



Ah -- but that was way back, past history...    They're all 'good' again - now that their perception has been 'corrected'...



lucky and good's picture

It is becoming clear China is in a situation similar to what America faced in 1929 following a period of rapid growth and credit expansion. To say the economy of China is shaky understates the situation. The kind of growth we have witnessed in China during the last several decades has been extraordinary and was driven by several "one time factors" that have be played out.

To those who doubt just how massive the problems are they only need look to the newly constructed city of Ordos in Inner Mongolia. Most of the new town buildings are empty or unfinished. Below is the latest in a series of articles concerning China's deteriorating economic situation.

Consuelo's picture



Deception is indeed, the 'art' of war.

Fahque Imuhnutjahb's picture

What's the problem?  The "Risk" Recycling conveyor is an infinity symbol, ergo, this can can go on indefinitely.

Dragon HAwk's picture

Chinese loans mature on a specified day/date so that their next creditor can be paid off with the same money.. the next day  that's all you need to know about Chinese lending.

Consuelo's picture
"...As Moody's Warns On Shadow Financing"


I stopped right there...




Consuelo's picture

"Allow us to explain how this could end."


Allow me to explain how this will end:


With a gaggle of 'experts' & 'analysts' caught flat-footed by deception, pointing a finger of righteous indignation, whilst the other (4) are pointing right back at them.



Chuck Knoblauch's picture

Moodys has no credibility.

ToSoft4Truth's picture

Another 'mystery'?  We live in mysterious times, clearly. 

MEFOBILLS's picture

Mankind, including the Chinese, has not learned its lessons about Credit as money.

Credit as money cannot pay its debts unless it is aimed into productivity GDP like channels.  Debt instruments, which are mirrors of credit, should have jubilee law built in as a feature for debt’s right to exist.    

China’s debt instruments are of mixed types.  They now have state banks, municipal banks, and private corporation banks.  Each of these debts will flux in different channels and make different demands.  Private demands will tend to be the most onerous.

  Debt instruments typically are created to hypothecate (make) new credit.  Other types of debt instruments are non-hypothecating and are just pure claims on credit.  Debt instruments will be stored at banking source, where the money is created.  Those sources (banks) may on-sell their instruments into markets, thus creating a bond and debt money market.   In other words, debts will travel away from source, and can even be disallowed from finding its former credit, another form of usury.  Exchange rate manipulations are a mechanism for disallowing credit to find its debt.

Hypothecating, and then buying and selling debts in markets is a form of slavery, especially when debts make claims outside of nature, and force mankind to run on a treadmill and rape the earth.

A municipal bond sold into money market, will grab pre-existing credit out of market, and then return it later when bond matures.  This type of debt has to be disaggregated from hypothecated debts.  Another example,   In U.S. mortgage backed securities did not make credit themselves, but shifted risk – as private banks could on-sell mortgage debts to special purpose vehicles at TBTF banks.  This allowed private banks to shift risk by shifting debts, and hence allow bar for hypothecation to be lowered.  Shifting of risk, to then allow a cycle of spiraling hypothecations are behind all credit bubbles, including China’s.

Chinese shadow banks borrowing from state banks is shifting of risk, or in other words, getting around the rules that State Banks enforce.

Debt money system are complex on purpose usually as a scheme to take rents; for example bond could be taken in by a bank and hypothecated to manufacture new credit.  So, looking at a bond, it is not always so easy to tell if it has equal volume of credit money mirrored.  Greek sovereign bonds were hypothecated by private commercial banks, so their Greek bonds created new Euro credit, and said Euro debts were outside of Greek law.  Don’t ever let your debts extend past your law.

In terms Chinese law, debts created at State Banks can be jubileed – that is, debt instruments are ripped up and thrown away.   This is a necessary action when finance claims against producers grow out of bounds with an economy’s real ability to pay.   Due to interest rate math, debt claims will grow exponentially and is an intrinsic feature of debt money systems.  This feature means that creditor is always over debtor, a usurious power relation.  This power relation is a fixture of the Western World – and now China.  Many Chinese economists study economics in the U.S., even at belly of the beast – Chicago School.

    Private banking corporations have profit motive and hence no desire to jubilee debts they hold.  When banking corporation profits are threatened, they will call loans which can cause system wide crash. Upon recall, former credit disappears into banker ledger.  Credit money comes from nothing and will cancel into nothing.  Upon cancelation, debt instrument also disappears.  In debt money systems, one person’s debts are another person’s savings.

State banks are not a very good idea as they hold debt instruments on their people, a form of state slavery. But, they can erase debts.

(The best system imho is sovereign money, which uses non debt Treasury money.  The money supply is nationalized but banks remain private.  Bankers work for fees, so exponential of usury is not a feature of the money supply.  China does not have a sovereign money system.)

Sovereign money is recalled with rent taxes, thus fiscal policy must be highly advanced, or Sovereign money won’t work.

China has a problem with its large number of private banks and shadow banks.  The shadow banks in particular seem to be borrowing large chunks of money from state banks, and then distributing the money as loans to small investors.  In terms of debt instruments, State Bank holds a large one from Shadow Bank, and Shadow Bank holds many debt instruments against households and small investors.  Shadow bank is private entity, borrowing from State Bank.

Chinese small investors then bought stock market securities, causing stock market bubble.  This action is similar to what happened in the 20’s in the U.S. causing that bubble and eventual crash into great depression.

List of Chinese state and municipal banks, which could jubilee should Chinese political leaders decide to make that choice are below:

(Note:  China canceled most of its bad communist era debts before it could be approved for MFN status, they did this using their state banks.)


State Banks

Agricultural Bank of China

Bank of China

Bank of Communications

China CITIC Bank

China Construction Bank

China Development Bank

Exim Bank of China

Hua Xia Bank

Industrial and Commercial Bank of China

People's Bank of China (Central Bank of PRC)

Postal Savings Bank of China


Municipal Banks

Bank of Beijing

Bohai Bank

China Merchants Bank

Bank of Dalian

Shengjing Bank

Bank of Jinzhou

Bank of Jilin

Harbin Bank

Industrial Bank

Fujian Haixia Bank

Guangdong Development Bank

Bank of Ningbo

Ping An Bank

Bank of Shanghai

Shanghai Pudong Development Bank

Shenzhen City Commercial Bank

Shenzhen Development Bank


Zhejiang Tailong Commercial Bank

TeethVillage88s's picture

"The wealth management products are just as bad. To an investor, they look like time deposits. But they pay higher rates because they take your money and invest it in risky loans to small businesses. Worse, Liang says that shadow banks often issue new WMPs to pay off old ones and dodge reporting bad loans. It’s like a big Ponzi scheme."

JenkinsLane's picture

Fuckin' Chinese Shadow Banking porn! Love it!