Fear of a Chinese credit crunch complete with its own version of misselling stalks world markets

25th June 2013


The reason to fear a shadow banking systems is quite obvious – the name is accurate – they operate in the shadows writes John Lappin. The fact China’s banking system may be afflicted is doubly concerning because the country does not operate to the same levels of transparency and disclosure as most Western developed economies. China is still a command economy in certain respects, albeit one that also has a roaring capitalist engine as well.

Even with supposedly higher western standards of disclosure, Wall Street, the City and many Eurozone banks still helped stir up the financial crisis, with their own version of shadow banking through mortgage backed securities and derivatives related to the insurance of these products. Banks were linked in shadowy ways, which saw governments have to step in with bailouts with all the subsequent economic pain that has caused. It saw massive contagion between and within the retail and investment banking sectors.

Global financial regulators are on the watch for anything resembling a shadow banking system. In the last couple of years for example, the Bank for International Settlements, effectively the central bankers’ central bank, became concerned about the growth in transactions through exchange traded products, though particularly the more exotic end of the market rather than anything a mainstream UK investor would be likely to be buying. That seems to have been a case of a regulator either erring on the side of caution or seeing its warning working.

Actually now BIS is more worried about central bank monetary policy i.e. quantitative easing as the FT reported recently.

But it looks like BIS has limited influence on China. China may be awash with two trillion dollars worth of shadow banking money – an unprecedented level according to ratings agency Fitch and reported in some detail on Australian website the Age.

The Chinese government and central bank have a lot more control in theory at least over the lending policies of regional banks. They can slow down credit growth by asking their banks not to lend more. Yet while it may not be identical to what happened in the West, it appears that banks have found the way around the restrictions and of course, China is huge and its regions have more autonomy than might be thought.

Unfortunately, in an echo of another Western habit, and as economist Shaun Richards noted in his excellent assessment on Mindful Money yesterday, it appears that banks are offering ‘wealth management products’ backed by short term credit that may need rolled over every three or six months.

That mismatch echoes at least some of problems encountered by Lehmans, Bear Stearns and in the UK Northern Rock to take one example in that ultimately these banks and brokerages were over-exposed and funded short term for longer term commitments.

There is one nasty little difference though. It may be that this mini-crisis may also be marked out by retail misselling if banks cannot honour these wealth management products something experienced in more mature markets such as the UK, the Netherlands and closer to problem in Hong Kong.

It also could mean that this Chinese version of the credit crunch directly damages the wealth of those all important middle class consumers. The Western version damaged wealth of course, significantly, but indirectly. It is a shame that one lesson we can’t share with emerging economies is how to avoid retail misselling having been through so much of it ourselves.

But the big concern must be economic. How much could this damage economic growth? Will China have to bail out these banks? How much does it say about the economic health and even legitimacy of borrowers of this credit? As Fitch’s Charlene Chu, the agency’s senior director in Beijing said to the Telegraph recently: “There is no transparency in the shadow banking system, and systemic risk is rising. We have no idea who the borrowers are, who the lenders are, and what the quality of assets is, and this undermines signalling”.

And what does it mean for the economies dependent on China? We have seen Threadneedle this week say it is cautious on stocks dependent on China. But another worry surely must be whether with the Eurozone and the UK still flagging economically, the US and ‘Abenomics’ Japan can do the heavy economic lifting, that we once hoped the BRICs but especially China could do.

And as Chinese markets fall, it may be wise to keep a check on your asset allocation as well.

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