China: Shadow Bank Inflows Are Critical To Sustain The Ponzi... But They're Falling

During the Party Congress, even China’s somewhat watered down versus of the free markets was suspended so as not to disturb the glorification of Xi Jinping as the nation’s greatest leader since Mao. Returning to “business as usual”, some commentators have been disturbed by the continued rise in government bond yields with the 10-year hitting 3.93% earlier this week.

Bloomberg described it this morning as a “tumultuous few days”.

We also noted Huachuang Securities Co. comment that bond holders may be about to get hit by “daggers falling from the sky,” if the Party adopts more aggressive deleveraging policies. In a far less sensationalist way, the Wall Street Journal has attempted a post-mortem on the recent sell-off in the Chinese government bond market.

Catching sight of a chain reaction in China’s markets is rare.


Carrying out a postmortem of a recent selloff in China’s $9 trillion bond market shows how it is becoming harder for Beijing to untangle its increasingly intertwined financial system. In the aftermath of China’s twice-a-decade party congress last week, yields on benchmark 10-year Chinese government bonds spiked to 3.9%, their highest in three years. Government bond futures fell.


Reasons proffered for the sudden rout ranged from expectations of higher U.S. interest rates to general fearmongering.

Having acknowledged the growing complexity of China’s financial system, WSJ provides a valuable insight, noting the relative stability of corporate bond yields during the recent sell-off in the government sector...

An important anomaly to note about the bond rout: as government bonds sold off, yields on less-liquid, unsecured Chinese corporate bonds barely moved.


That is atypical in an environment of rising rates - usually, bond investors shed their less-liquid holdings and hold on to assets that are more easily tradable, like government debt.

Using this handy (kind of) diagram of flows in China’s financial system...

...WSJ tries to explain “how the selloff in China really worked”.

In essence what happened is that, as funding costs for Chinese banks have risen, they have been forced to compensate by placing more money in the shadow banking sector, with all the risks that entails (i.e. leverage and risky assets). Here’s the Journal’s version.

Let’s start with the travails of China’s small and midsize lenders that—like most banks—fund themselves by taking in customer deposits and by borrowing in wholesale markets.


In China, the latter has increasingly meant issuing short-term bonds known as NCDs, or negotiable certificates of deposit. The trouble for Chinese banks of late is that both these funding sources have become expensive: Borrowing costs have risen as Beijing pursues its deleveraging campaign, while bank-deposit growth has also been slowing.


To balance out these rising costs, banks have been placing more of their money with so-called nonbank financial institutions—the likes of trust companies, funds and securities companies—that offer high returns from investing in various markets, from bonds to stocks and commodities.


Deposits placed by banks with these nonbanks - the bulwarks of China’s infamous shadow banking system - had grown to more than $4 trillion as of September this year.

Okay, this is where things get more interesting.

Please bear in mind that (as we’ll explain later) a key pillar supporting the stability of China’s financial system is the maintenance of rising flows into the Chinese shadow banks.

This Bloomberg chart shows the rapid growth in China’s shadow banking system in recent years.

The WSJ explains that the reduction in flows into the shadow banks has led to redemptions and something had to be sold quickly...

But with less funds coming into banks now, less can go out. That has led to trouble for the nonbanks, which, after years of only ever-higher inflows, have started facing redemptions.


Banks’ claims on nonbanks have dropped 2% since peaking in June, according to Wind Info, equivalent to a $90 billion withdrawal of funds.


In addition to these redemptions, the cost for nonbanks of juicing returns on their investments by leveraging up has also risen because of the higher interest rates mentioned above.


That brings us to the bond market. Faced with redemptions, nonbanks have needed to sell something, and quickly. Offloading highly liquid government bonds has proven the easiest option.


Meanwhile, the nonbanks have held on to their higher-yielding corporate bonds, which at least have the benefit of helping them to maintain high returns.

We think that the Journal’s analysis is correct…but it doesn’t fully appreciate the bigger picture regarding shadow banks’ need to “maintain high returns”.

China’s shadow banks are, in part, engaged in Ponzi schemes, for example in the $4 trillion Wealth Management Products (WMP) sector. In May 2017, Forsea Insurance, one of China’s largest insurers, warned that there would be “mass defaults and social unrest” if it was prevented from selling new WMPs to meet payouts. See “Chinese Insurer Warns Of ‘Mass Defaults, Social Unrest’ Due To ‘Mass Redemption’ Run”.

A month earlier, Minsheng Bank, China’s largest private bank, was found to have committed a RMB 3.0bn fraud by selling non-existent WMPs. See “Investors Rage After 3 Billion Yuan Vanish From China's Largest Private Bank”.

The sell-off in Chinese government bonds implies that the deleverage in shadow banking we identified in September in beginning to bite.

We are in the last lap of the Chinese Ponzi as, piece by piece, the whole decrepit system is being exposed. In the end, it will boil down to how many trillions of RMB the PBoC needs to print to make the banks and their shadow banking relatives whole.


caconhma edotabin Sat, 11/04/2017 - 10:44 Permalink

China has a "controlled-economy" and it cannot be judged by the US "fiat-driven economy" rules/standards.Therefore, a demise of Chinese "economic miracle" is highly exaggerated. Granted, as a "controlled-economy" China has its own serious problems but it is not a Ponzi economy by any means or standards.Specifically, China is extremely sensitive to having an access to international markets and natural resources. As soon as, thanks to US neocons, China has unlimited access to Russia natural resources, the majority of China growth problems are addressed. In other words, the USA is fucked up by zio-banking mafia big time!

In reply to by edotabin

Crazy Or Not Justin Case Sat, 11/04/2017 - 06:30 Permalink

Whilst its challenging to remain neutral watching a usurper make a play for the throne. China is playing a strong game. Once the PetroYuan & PetroRouble kick in in 2018 there will be a great stabilizing effect to both these currencies. The timing of Trump's extended asian tour is no accident and a greater military presence in the area would give some leverage. interrupting yellowcake shipments enruote to Bejing, and disrupting China's foothold on Spratley Islands will likely be part of a more public play to stare down the throat of Kim's posturing in NK. NK as Port China's Lighthouse, is a bone worth wrestling for.

In reply to by Justin Case

Gorgeous Justin Case Sat, 11/04/2017 - 09:31 Permalink

Dedollarization is their biggest motivation for blockchain.  Not cryptocoins.  They will still use their national fiat, but use blockchain tech to bypass swift and sanctions on their petro exchange.  And to stop paying the fed interest on the frns. And as payback for US interferance in Syria, Spratleys, Kiev, Donbass, etc., etc.

In reply to by Justin Case

Gorgeous Buckaroo Banzai Sat, 11/04/2017 - 14:36 Permalink

ChiComs piggybacking on.  It's what they do.They could indeed just use existing BTC or some existing coin.  But no need.  The don't need or want a new coin. Rhey need a means to conduxt peteo exchange in. national currencies.  Besides, all the elements of BTC are free to all.  ISO std hash, blockchain ledgers are all open source and public domain. BTC does have the broadest network but these are primarily investors, IMO.   States only need to start with a few nodes between the AIIG, BRICS bank, major commercial banks, shipping, agriculture, energy, maybe tourism agencies. Russia and China could co-develop an open blockchain system and then let the ROW join when ready.  To entice adopters, they do have (some gold they might tie in in creative ways.

In reply to by Buckaroo Banzai

The Ram ebworthen Sat, 11/04/2017 - 09:39 Permalink

Yes, China will have its days in the sun as empire, but if the American empire lasted approximately 100 years (let's say after WWI), the China may be lucky to last 25 years.  Of course, they are making the same mistakes as the US empire on steroids, namely, relying on massive printing of fiat currency, and playing a mercantilist game that will end badly. We may also talk about about industrial pollution that will have long term effects.  If you want to see what I am talking about visit  Great web site to see how cheap Chinese production is sold well below production and shipping costs to keep the western economies in the consumption game.  The problem is that China will need to exponetially increase it's debt to keep the game going.  Yes, things are good for them now, just as things were good for America in 1955!  Folks, its the same game.  America ruled production in 1955 of just about anything worth buying.  I have no problem with the Chinese, but I have a problem with people who do not see that the Chinese are not exceptional.  They are playing an old game, and here in the technology age, things happen much much quicker.  Therefore,  the rise and fall happens much quicker!  Pretty much a blink of the eye in human history!!

In reply to by ebworthen

novictim Fri, 11/03/2017 - 20:06 Permalink

Good news, Comrades!  Stocks up 28% over prior government estimates!  And, even more exciting, reports from the Malabar Front indicates that the war with Oceania is now within measurable distance of its end!  Double rations of victory gin for everyone!

novictim Fri, 11/03/2017 - 20:23 Permalink

And so the Chinese smoke screen of wealth is being traded for medium and high valure western realestate.  But the real basis of the wealth is fake.  SO WHO IS LEFT HOLDING THE EMPTY BAG OF USELESS CHINESE STOCKS when the SHTF? Western 401ks and Mutual Funds, retirement accounts and all the little people.  But the Chinese Oligarchs will still own a house or several housed or hundreds of houses.  Does that sound fair or like a policy consistent with America First? 

The Ram novictim Sat, 11/04/2017 - 12:22 Permalink

Yes, but when the shit hits the fan in America, will the Chinese be able to protect their high and medium value properties?  Can they survive quadruple increases in property taxes, particularly on high value commercial property?  Those properties may end up being a ball and chain rather than an asset.

In reply to by novictim

MaxThrust Fri, 11/03/2017 - 20:41 Permalink

This article was informative but did not go into the ramifications of "if" the PBoC prints to save the Banking system nor did it include any reference to China backing the Yuan with gold as a way to shore up the system if such a move would have any effect on propping up this ponzi. 

G_T_A_44 Fri, 11/03/2017 - 20:44 Permalink

The entire Global Financial Structure broke in '08. Nothing to date has been repaired nor, its root causes addressed. In fact, conditions today are far worse off than in '08. The global economy fed by global CB's in a Centrally Planned manner, have and continue to operate under the guise of Ponzi.No one is excluded, particularly the western hemisphere/economies from where its origins began and spread throughout the globe in brushfires.However, the Boomerang always returns to its origination.

rlouis Fri, 11/03/2017 - 20:44 Permalink

Both China and Russia required the US to develop and sustain their economies. The US' financial support for the USSR throughout the 20th century is astounding, and I doubt China ever could have accomplished its growth without US technology and markets.   As much as I would like to believe in utopia, the conclusion that the collectivist models of communism and socialism don't work is unavoidable. Not only because they violate the laws of economics but also because they contain an intrinsic corruption that destroys the spirit of cooperation.  Hayek explained it quite well in his Road to Serfdom.Expecting that global economies aren't going to crash like Venezuela because no other country has leadership that is as corrupt and incompetent  as Venezuela ... lol. Can fiat currencies avoid going the way that Zimbabwe's fiat has, repeatedly?

DavidFL Fri, 11/03/2017 - 20:57 Permalink

I call BS. As the 10yr yield in China rises, institutional money from the west (US / EU) will flow toward yield. In other words, lock in bond price profit from the west; hold the money till China yield rises - then strike.  A rising rate structure in Chinese bonds may be the catalyst which finally breaks the west bond bubble. Be careful.

Juliette Fri, 11/03/2017 - 21:18 Permalink

China at least got a huge economy which actually produces things like iphones, computers, laptops, or cars. Ponzi my ass. They even produce the world's finest cars there, BMW, Volkswagen, Audi and Mercedes, and own the patents for China for these cars since all these car factories are joint ventures.

The Ram Juliette Sat, 11/04/2017 - 12:28 Permalink

They produce these things FOR NOW.  Remember, American was once the bastion of producing anything worth owning.  Boys, its a big cycle.  If you want to be very futuristic, predict the next bastion of production after China.  The Chinese empire will be very short lived.  We are living in the age of information when things go up and down in a blink of the eye.  Remember, nothing is solid.  Pay no attention to that man behind the curtain.

In reply to by Juliette

roddy6667 Fri, 11/03/2017 - 23:04 Permalink

Only about 10% of Chinese are in the market. It has long been assumed that almost all this is discretionary income and won't bankrupt people if they lose it all overnight. The shadow banking system is mostly run by real estate developers to raise cash for their next project. They pay yields of 8 to 18% which you get by buying trusts in banks and "wealth management companies" everywhere. It is higher risk than a CD. Some builders bite off more than they can chew and fall behind or fail. It's the same everywhere. Look at the new condo market in Miami. However, just like the people who go into the market to get returns they should not expect, most of them could lose all or most of their money and still get by. The average Chinese family has their cash parked in a CD or in a second or third home they own.

gammab0y roddy6667 Sat, 11/04/2017 - 06:20 Permalink

I'm no expert on China, but i dont believe this.   To have such a long and ridiculous bull market,  especially in real estate,  creates an environment of where eventually everyone gets sucked in.   Even the hard core skeptics get sick of watching their friends get rich. It is human nature.   And in a country with no capitalist history,  weak corporate governance,  and state funding shenanigans,  I have to believe that when the financial tide rolls out, the failures and shock will be of an historically epic nature. 

In reply to by roddy6667

JLM Sat, 11/04/2017 - 09:16 Permalink

"there would be “mass defaults and social unrest” if it was prevented from selling new WMPs to meet payouts."  WMP is a new term to me, "Weaponized Mass Ponzi's".

Let it Go Sat, 11/04/2017 - 10:22 Permalink

It is difficult to ignore that China's central bank has warned extreme credit creation and trouble in the shadow banking system could lead to a full-blown financial crisis. In response, they continue pumping out liquidity. If they don't the whole system might seize up and cease to function, on the other hand, such actions only create more problems going forward. The article below looks at how China's policies are affecting global markets. http://China, China, China, It Is All About China html

TGDavis Sat, 11/04/2017 - 12:27 Permalink

Sorry friends,  a country that has 3.5 trillion in foreign reserves, a boat load of factories, and a hard working population,  doesn't have any problems. 

ZeroPoint Sat, 11/04/2017 - 16:55 Permalink

They are using Western style financial fraud to build themselves up. When it fails, it will fail everywhere, except they will restart with gold.