Disaster has apparently been averted in what some referred as a potential precedent setting delinquency in China.
China Credit Trust Ltd. loaned funds from the trust, known as “2010 China Credit/Credit Equals Gold #1 Collective Trust Product,” to a coal company called Shanxi Zhenfu Energy Group. It has since collapsed due to its failure to obtain licenses needed to operate. The trust reached an agreement with investors who contributed to the 3 billion yuan ($496 million) product. Investors will recover their initial contributions but none of the promised interest, according to Reuters via finance magazine Caixin.
The news panicked global markets as the Jan., 31 maturity date of the product approached. The general perception that these types of shadow banking products are backed by partner and state banks was put to a test that it has apparently passed for now. Though crisis has been averted, many analysts believe it’s a matter of time before a major default occurs with these types of shadow banking products.
What Is Shadow Banking?
The shadow banking system encompasses all the intermediary financial institutions that bundle and securitize investments, then lend the funds to consumers. These institutions are not actual banks and don’t receive deposit like a traditional bank, thus are not regulated in the same way. The etymology of the term isn’t concrete. But the International Monetary Fund put it best, saying that shadow banks are scary because of their inherent obstruction of the true size and shape of the actually object.
Some economists estimate that shadow banking is now responsible for more than 60 percent of all loans in the United States. Moody’s Analytics, an industry leader in bank stress testing, found that China’s shadow banking products doubled from 11.7 trillion yuan in 2010 to 20.5 trillion in 2011 alone.
Bill Maldonado, the CIO of HSBC Asia, told CNBC that the term “shadow banking” carries unwarranted negative connotations with it. He claimed that all activities by these institution are tightly regulated.
New Regulations In China
The Wall Street Journal obtained a document from the Chinese Cabinet that contained new rules and regulations limiting how big shadow banking institutions can get. The plan is not a crackdown on the sector. Rather, State Council document 107 seeks clarification on what responsibilities the People’s Bank of China (PBC) and other regulatory agencies have in policing shadow institutions.
China took similar action in December with Bitcoin. The PBC told Bloomberg that the unregulated, decentralized cryptocurrency “interferes with normal monetary policy operations.” It banned all financial institutions in the country from facilitating Bitcoin transactions. The actions by the PBC caused Bitcoin to dropped more than 20 percent in less than 48 hours.
Effect On Future High Yield Products
The agreement between investors and China Credit Trust is essentially a bailout, reports Reuters. Local media reported that 50 percent of the needed funds would come directly from the government of Shanxi province. Another 25 percent will be paid by the Industrial and Commercial Bank of China (ICBC) and the remainder by China Credit Trust.
The bailout reinforced the perception that high-yielding schemes like this one are safe havens for investors because of the de-facto guarantees by state banks. Neither ICBC nor China Credit Trust commented on the bailout.
Blake is a day trader who closely follows, and writes about, fiscal policy. When he does step away from his computer, he likes to cook.