China shadow bankers pray to be systemically risky

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Man looks at the Pudong financial district of Shanghai
A man looks at the Pudong financial district of Shanghai November 20, 2013. With a shift in tone and language, China's central bank governor has dangled the prospect of speeding up currency reform and giving markets more room to set the yuan's exchange rate as he underlines broader plans for sweeping economic change. The central bank under Zhou Xiaochuan has consistently flagged its intention to liberalise financial markets and allow the yuan to trade more freely, even before the Communist Party's top brass unveiled late last week the boldest set of economic and social reforms in nearly three decades. REUTERS/Carlos Barria

HONG KONG, Aug 23 (Reuters Breakingviews) - China’s falling property sales are subjecting shadow bankers to an unprecedented stress test. China’s $3 trillion trust industry, which caters to wealthier clients looking for relatively high returns, is the latest to come under official investigation. Part non-bank lenders, part money managers, a lot of their assets were invested in property, directly or indirectly. As housing sales fell 32% in the first half of the year, trusts defaulted on roughly $9 billion in products related to real estate developers, according to data provider Use Trust.

Non-bank financial institutions played a big role in China’s overheated property boom. Because prices rose for decades despite repeated efforts to cool them, investors tried to borrow as much as they could. Their willingness to pay double-digit interest rates for additional leverage attracted investors who thought China’s property sector was too big to fail. Home buyers financed bigger mortgage down-payments by borrowing surreptitiously from shadow bankers while developers expanded their land banks by taking out trust loans. Struggling companies in unrelated industries often pledged real-estate assets as collateral for shadow loans. Much of this often got repackaged into opaque wealth-management products peddled to individuals.

Officials were aware of the moral hazard long before property prices began falling. They tried to ensure that high-yield products could only be sold to institutions or “qualified investors” with adequate financial buffers, and began locking heavily indebted developers out of conventional credit markets. They suppressed the usage of alternative instruments like peer-to-peer loans and bankers’ acceptance notes.

China's shadow banking channels have shrunk dramatically

That has had some effect. Outstanding off-balance sheet WMPs had declined to 25% of nominal GDP last year from 36% in 2017, per Fitch Ratings, although the total balance has grown to $4.2 trillion. Official data shows the property market formally accounts for only 11% of trust assets, down from 14% in 2020. That obfuscates all the real estate hidden inside other asset classes, though. An analysis of trust firms by local finance magazine Caixin found property still accounted for over 50% of business at many of them.

While they play a role funding private companies, trusts are not critical economic actors. Real estate has become an engine of economic inequality in China, and President Xi Jinping’s “common prosperity” campaign suggests he won’t mind rich speculators losing their shirts. Shadow bankers might pray that auditors discover trusts are too risky to let fail; that is their only hope of a bailout.

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(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)

CONTEXT NEWS

The Chinese government has ordered an audit of the trust industry, Bloomberg reported on Aug. 9 citing people familiar with the matter. Auditors are examining the books of at least 20 firms to see if they pose a risk to financial stability. Trust lenders help channel deposits from qualified investors into riskier assets in exchange for relatively higher returns.

Editing by Antony Currie, Katrina Hamlin and Thomas Shum

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Asia Economics Editor Pete Sweeney joined Reuters Breakingviews in Hong Kong in September 2016. Previously he served as Reuters' chief correspondent for China Economy and Markets, running teams in Shanghai and Beijing; before that he was editor of China Economic Review, a monthly magazine focused on providing news and analysis on the mainland economy. Sweeney came to China as a Fulbright scholar in 2008, and in that role conducted research on the Chinese aviation industry and outbound M&A. In prior incarnations he helped resettle refugees in Atlanta, covered the European Union out of Brussels, and took a poorly timed swing at craft-beer entrepreneurship in Quito even as the Ecuadorean currency collapsed (not his fault). He speaks Mandarin Chinese, at the expense of his Spanish.

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