China's Shadow Banks are Evolving

WILL rising defaults and stricter rules halt the breakneck growth of China’s shadow banks? When one of the country’s many trust companies, which sell high-yield investments, warned earlier this year of a looming default on one of its products, its clients reacted with anger and the wider market with alarm. As panic spread, regulators orchestrated a bail-out of the product, reassuringly named “Credit Equals Gold #1”. But in recent weeks investors in its sibling, “Credit Equals Gold #2”, have met a crueler fate. It is backed by loans to a bankrupt coal-mining firm which came due in July and have since gone unpaid. Investors will not get their money back until collateral can be seized and sold. That process may take more than a year. The episode, naturally, calls into question the widespread belief that such investments are safe because they are marketed by big, state-owned financial institutions.

Shadow banks, which barely existed before China’s credit surge in 2009, now have assets of at least 30 trillion yuan ($4.9 trillion), or more than 50% of GDP, according to estimates by ANZ, a bank. The government’s attempts to slow the pell-mell growth in credit extended by conventional banks have only steered more business to their shadowy cousins. In fact, investments from mainstream banks have been the shadow banks’ biggest source of funds. So the government has promulgated new regulations that make it harder for conventional lenders to do business with the duskier sort.

Assets managed by trust companies, the most common form of shadow bank, have surged fivefold since the start of 2010 to 12.5 trillion yuan. But growth in the second quarter was tepid and June marked the first monthly decline. The stock of bank-acceptance drafts—another popular form of shadow finance—is also falling. Perhaps as a result, fears that the problems at shadow banks will hobble the economy seem to have faded. At any rate, the default of Credit Equals Gold #2 barely made a ripple in markets.

Yet it is far too soon to call time on China’s shadow banks.

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