Wall Street Journal
June 11, 2011
The liabilities of China’s shadow banking system are unknown and uncontrolled
By ANDREW COLLIER
In October, I sat down in Nanjing with a senior banker for one of China’s “Big Four” state banks. I asked him about the new regulations just put in place by Beijing to restrain the growth in lending. “There are ways around these rules,” he said.
Despite a consistent crackdown on bank lending by senior officials in Beijing, it’s not clear that local governments are listening. A two-week tour this month through Fuzhou, Shanghai, Beijing and Chengdu highlights the extent to which local banks and governments are devising new and clever ways to supply money to capital-starved businesses without going through official channels. These new sources of capital raise doubts about Beijing’s control over the financial system, as well as its ability to reduce inflation and forestall a crash in the property market.
One property developer in Fujian Province explained his method for raising capital. To build a nearly 2 billion yuan ($308 million) building, he has raised 1 billion yuan through presales of apartments, but is still short about 800 million yuan to complete construction. Banks won’t lend to this sector owing to recent Beijing efforts to cool the property market. Instead, the developer is looking for an innovative source of capital: pledges of future personal mortgage loans as collateral, a collateral that doesn’t yet exist. Although this type of financing is unusual and the details aren’t completely clear, the developer requires future residential buyers to purchase their mortgages through the bank that provides the developer a loan.
Banks in several provinces have found another way to circumvent the rules. Two years ago, the banks started packaging project loans, often for new property developments, and selling them to wealthy investors as investment trusts. Despite high interest rates of 12% to 20%, there was demand among the borrowers due to a shortage of capital. However, the China Banking Regulatory Authority (CBRC) got wind of this tactic, and banned it last year. To get around this, the local bank branches have begun to arrange “meetings” between their corporate borrowers and their high net worth clients, where the lenders put together the same loan packages. The bank provides “implicit” support for the loan but it never shows up on the books.
A truck distributor on China’s coast described another tactic. The distributor’s contracts contain a clause that requires the distributor’s supplier of trucks to “help” the distributor unload unsold trucks. Rarely invoked in good times, this is a form of lending guarantee that could come back to haunt the supplier in bad times.
The local governments themselves are getting creative, too. Since they officially can’t issue bonds, they have created “platform” companies as investment vehicles, often using land as capital. But the central authorities, through the People’s Bank of China and the CBRC, have put a stop to the growth of these trusts. So the local governments are turning to non-bank sources of capital that can’t be traced by the regulators—usually state-owned firms.
“The local government can’t inject [funds] into the platforms, but they can sell state-owned shares or inject SOE [state-owned enterprises] capital,” according to the assistant general manager at a branch of a state bank. The regulators can control lending to the corporations, but there’s not much they can do once the corporates have the money.
All of these, and plenty of other tactics taken together, add up to a financial system that in some respects is running out of control. The more liabilities build up out of sight of regulators, the more serious the risk that a financial crisis could catch authorities by surprise. It’s not a question of the competence of the authorities. Both the PBOC and CBRC are doing their best to manage the situation, and appear to have a pretty good idea of the contours of all this off-balance-sheet lending. But precise data are in short supply, a fact that would stymie even the best regulators.
This problem is twofold: It is very difficult to capture information about non-bank sources of lending, which comprise everything from corporate balance sheets to unrecognized promises for future profits. Second, the bank regulators control only the banks, but not the whole economy. They are in a tug of war both with China’s planning board—the National Development and Reform Commission—and local governments, all of whom have a vested interest in spending as much money as possible.
Arguably, this shadow banking system has a positive side. It is teaching wealthy Chinese how to evaluate the costs and benefits of recycling their savings into profitable projects, instead of leaving them in low-yielding bank deposits that could be funneled into useless investments. One of my former interns said her father, a metals trader in Shanghai, constantly receives investment proposals for private projects and probably has a good sense of what is a good and bad investment.
But the downside is more frightening. There is a rampant growth of credit, uncontrolled or even incalculable by the country’s top leadership. This means the financial system is
generating liabilities that could easily turn sour and, come some kind of crisis, prove difficult to clean up. Does this remind anyone of America’s subprime crisis?
Mr. Collier is an independent China analyst and the former president of the Bank of China International’s U.S. office.
A truck distributor on China’s coast described another tactic. The distributor’s contracts contain a clause that requires the distributor’s supplier of trucks to “help” the distributor unload unsold trucks. Rarely invoked in good times, this is a form of lending guarantee that could come back to haunt the supplier in bad times.
The local governments themselves are getting creative, too. Since they officially can’t issue bonds, they have created “platform” companies as investment vehicles, often using land as capital. But the central authorities, through the People’s Bank of China and the CBRC, have put a stop to the growth of these trusts. So the local governments are turning to non-bank sources of capital that can’t be traced by the regulators—usually state-owned firms.
“The local government can’t inject [funds] into the platforms, but they can sell state-owned shares or inject SOE [state-owned enterprises] capital,” according to the assistant general manager at a branch of a state bank. The regulators can control lending to the corporations, but there’s not much they can do once the corporates have the money.
All of these, and plenty of other tactics taken together, add up to a financial system that in some respects is running out of control. The more liabilities build up out of sight of regulators, the more serious the risk that a financial crisis could catch authorities by surprise. It’s not a question of the competence of the authorities. Both the PBOC and CBRC are doing their best to manage the situation, and appear to have a pretty good idea of the contours of all this off-balance-sheet lending. But precise data are in short supply, a fact that would stymie even the best regulators.
This problem is twofold: It is very difficult to capture information about non-bank sources of lending, which comprise everything from corporate balance sheets to unrecognized promises for future profits. Second, the bank regulators control only the banks, but not the whole economy. They are in a tug of war both with China’s planning board—the National Development and Reform Commission—and local governments, all of whom have a vested interest in spending as much money as possible.
Arguably, this shadow banking system has a positive side. It is teaching wealthy Chinese how to evaluate the costs and benefits of recycling their savings into profitable projects, instead of leaving them in low-yielding bank deposits that could be funneled into useless investments. One of my former interns said her father, a metals trader in Shanghai, constantly receives investment proposals for private projects and probably has a good sense of what is a good and bad investment.
But the downside is more frightening. There is a rampant growth of credit, uncontrolled or even incalculable by the country’s top leadership. This means the financial system is
generating liabilities that could easily turn sour and, come some kind of crisis, prove difficult to clean up. Does this remind anyone of America’s subprime crisis?
Mr. Collier is an independent China analyst and the former president of the Bank of China International’s U.S. office.