Shadow Banking in China – Implications of Defaults

While informal lending is significant, it is not big enough to bring down the entire system.

Trends:

  • Informal lending, or shadow banking, has become very active across China since earlier this year
  • It has recently caught both media and government attention after multiple cases of “underground trust” went burst
  • The situation is worst in Wenzhou, where a number of business owners have gone into hiding or even committed suicide

Drivers:

  • A credit tightening policy was implemented by People’s Bank of China in early 2011
  • The state-owned banks prefer to lend to state-owned enterprises and large private companies, leaving little credit available to SMEs
  • Negative real interest rate and lack of investment choices prompt people to seek a higher return through informal lending

Implications:

  • The non-performing loan ratio is going to rise during any economic slowdown, triggering defaults among informal lending entities, many of which are ponzi schemes
  • The most risky form of informal lending is curb market lending, where many uninformed individuals and small companies will put money together to lend to highly risky or even “phantom” projects with virtually no due diligence
  • The informal lending market is estimated to be one-fifth the size of the total loan market, while the curb market lending is about 1/3 of total informal lending. While these numbers are significant, they are not big enough to bring down the entire system

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