The World Bank’s top economist, Kaushik Basu, is worried about China’s reliance on credit to fuel growth. He said last week that eventually credit will catch up with it: “We’ve seen that in the U.S. in 2008, and China may have to face up to that sometime in the coming year, or couple of years because of its bloated finances.” Back in April, the IMF’s Global Stability Report warned that China was risking a financial crisis if it didn’t rein in borrowing, and that the country should settle for lower growth in order to save itself from credit calamity (the WSJ has a good summary of the report). “Pockets of stress have already begun to emerge, particularly in the trust sector, with spillovers to other parts of the financial system,” the report says.
The Financial Times is in the middle of a series investigating the shadow banking sector, starting with Chinese trust products, which is often where companies turn when they can’t get a bank loan in China. The FT describes trust products as “lightly regulated trust companies … making high-interest loans to risky borrowers, repackaging them and selling them through banks.” Trust products are only supposed to be sold to investors who have 1 million RMB to spend, to make sure investors have money to lose, but the FT reports this rule is often ignored. The story also quotes research analyst Charlene Chu, who says within the Chinese shadow banking sector, “bad decisions and bad risk management are the norm.” Yet, many borrowers assume local governments will be there to bail them out if they can’t pay their debts.
David Keohane thinks there should be more worry about Chinese trusts. He quotes a recent Credit Suisse report that says, basically, a combination of government bailouts, bank rollovers, and acquisitions has saved the shadow banking sector in the short term, but things aren’t looking good for the future. “The basic point is that it’s improbable that local governments are going to be able to handle all of this on their own so, as CS suggest, it’s the central government which is going to need to step in. Or not,” says Keohane.
The Economist has a good overview of the state of Chinese trust products. It details the reasons why China, in the event of a mass of trust product defaults, would likely not see a huge financial crisis like 2008, even though China’s shadow banking system has many similarities to the West in the mid 2000s:
The main reason why a calamitous run on Chinese shadow banks is unlikely, however, is that the country has the capacity to absorb lots of non-performing loans. Its debts, both shadowy and well-lit, are much smaller relative to GDP than they were in most Western countries before the crisis struck. More important, China’s central government and the big state-owned banks are still in rude financial health and could intervene to buy up troubled assets, preventing the credit market from seizing up. Currency controls would stop panicked Chinese from spiriting their money out of the country.
— Shane Ferro