China's Shadow Banking Crisis
By Lorenzo de SimonePublished April 10, 2014By Lorenzo de Simone, 4/10/14
In the aftermath of the European economies sovereign debt crisis and the global financial crisis that severely damaged the United States economy, which is still today struggling to regain full employment, attention has no shifted towards China and the potential of a serious financial fallout.
A serious issue in China is that after the GFC in 2008, in order to offset the effects of the crisis the Chinese government encouraged a large credit boom. The credit was predominantly used to finance real estate construction and infrastructure which according to the Chinese bureau of statistics led to a 45% growth rate in the period of 2008-2013. At the same time the International Monetary Fund reports a $13 trillion increase in bank loans, bonds and various non-bank financing. More than two-thirds of this increase was in nonbank financing meaning credit that flowed through non-financial institutions other than regulated banks.
The most serious problem in China is therefore a shadow-banking crisis, one where various bonds are growing rapidly without sufficient form of control. The shadow banks are very much a moral hazard trade with credit busts that are being driven by uncompetitive nonbank markets and losses on bank loans. The Chinese strategy for dealing with this problem is similar to what happened in the U.S and Europe, let the banks slowly recognize their losses and then support the banks with credit from the central bank as needed. However, the high profitability of Chinese banks makes them far more resilient than the American and European banks. Another advantage for China is a very high national savings rate that will ensure growing deposit rates which leads to a growing labor force and investment in capital.
A slowdown in Chinese credit growth is however very probable, and G.D.P growth could easily turn out below China's 7.5% target. Would this have a detrimental effect on the world economy? The answer is most likely no, with China's G.D.P at only a fraction of the world economies including that of the United States and the European Union at $16.7 trillion and $17 trillion respectively, stagnating growth in China would have a limited impact on these markets. China's main link with the rest of the world is through trade, as the U.S and Europe export relatively little to China, the direct impact on them would therefore be very limited. Those most seriously affected would be raw material and manufacturing exporters such as Russia and Germany. The net effect would therefore be relatively small for growth in the U.S and Europe but detrimental for strong industrial nations that rely on goods imported by China. However the fears of another financial crisis are very far-fetched.