Battling Shadow Banking in China

IN THE town of Jingjiang, a few hours’ drive from Shanghai, Yangzijiang Shipbuilding is making 21 huge container ships for Seaspan, a Canadian shipping firm. An enormous sign declares, “We want to be the best shipyard in China.” It is certainly among the most profitable, earning 3 billion yuan ($481m) last year. But only two-thirds or so of that came from building ships. The rest came from lending money to other companies using a local financial instrument called an entrusted loan. This puts Yangzijiang at the forefront of another industry: shadow banking.

A decade ago, conventional banks, which are almost all state-owned and tightly regulated, accounted for virtually all lending in China. Now, credit is available from a range of alternative financiers, such as trusts, leasing companies, credit-guarantee outfits and money-market funds, which are known collectively as shadow banks. Although many of these lenders are perfectly respectable, others constitute blatant attempts to get around the many rules about how much banks can lend to which companies at what rates.

Although bank lending remains far bigger than the shadowy sort and is still expanding at an astonishing pace, its rate of growth has recently stabilised. The growth of some of the more worrying forms of shadow lending, in contrast, is accelerating (see chart). Shadow banks accounted for almost a third of the rise in lending last year, swelling by over 50% in the process.

Thus far, most of the concerns about shadow banking in China have centred on trusts. By offering returns as high as 10%, they raise money from businesses and individuals frustrated by the low cap the government imposes for interest rates on bank deposits. The interest they charge to borrowers, naturally, is even higher. They lend to firms that are unable to borrow from banks, often because they are in frothy industries, such as property or steel, where regulators see signs of overinvestment and so have instructed banks to curb lending. Over two-fifths of Yangzijiang’s loans go to property developers in smaller Chinese cities; land makes up nearly two-thirds of its collateral.

China’s economy is slowing. It has grown by 7.6% for the past two years, the slowest rate since 1990. Several trust products have defaulted, although investors in most of them have got their money back one way or another. Over $400 billion-worth of trust products are due to mature this year—and borrowers will want to roll over many of those loans. Many observers worry that investors will lose faith in trusts, prompting a run, which may, in turn, blight certain industries and other parts of the financial system. No country, pessimists point out, has seen credit in all its forms grow as quickly as China has of late without suffering a financial crisis.

link.