Authorities in China have cracked the country's biggest-ever underground banking network, which handled illegal foreign exchange transactions worth 410 billion yuan ($64 billion), police said Friday.
The bust comes amid a monthslong crackdown on illicit outflows, which officials say disrupt China's financial management, facilitate corruption and help terrorists and criminals launder their dirty money.
Over 370 people were detained, prosecuted or otherwise reprimanded in the case, police in Jinhua city said in a statement on their website. Jinhua is in Zhejiang province on China's eastern coast, a zone known for its shadowy financial networks.
Police said one leader of the Zhejiang network was a man named Zhao Mouyi, who transferred over 100 billion yuan overseas using 850 different bank accounts and a dozen Hong Kong front companies. It took police nearly a year to sort through over 1.3 million suspicious transactions, they said.
Since April, Chinese authorities have uncovered over 170 big cases of underground banking and money laundering worth over 800 billion yuan ($126 billion), the state-run People's Daily reported.
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.
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.
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