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China's shadow banking

Publication Date : 11-02-2014


The so-called “emerging markets” are now on the ropes. This matters to Malaysia.

The so-called “Fragile Five” have been scrambling to raise interest rates to curb inflation: Turkey, South Africa and India have all done so.

We’ve also been affected, though Malaysia’s economy is fairly resilient.

China’s economy – Southeast Asia’s engine of growth – is still expected to grow at a stable 7% this year.

Moreover, inflation is under control at 2.5% in December 2013 and the yuan is steady against the US dollar.

China’s tight capital controls also shield it from the United States’ tapering of its quantitative easing.

Nevertheless, all is not well with China’s economy and we should take notice of this.

Beijing is facing a potent threat in the form of its shadow banking system.

I warned about this last year (“Systemic risk over China’s mid-tier banks”, The Star, July 23) and it appears my concerns have not been far-fetched.

China has become more reliant on informal sources of financing over the past decade.

In 2013, there was a drop in recorded bank loans, whereas loans from shadow banking are currently as high as 47 trillion yuan (84% of GDP).

What is more worrying is the fact that shadow banking institutions (such as hedge funds) are highly unregulated, thus encouraging excessive risk-taking.

We got a taste of what could go wrong last month when the China Credit Trust (CCT) came perilously close to defaulting on a three billion yuan investment product issued in 2011.

CCT’s loan was distributed by the Industrial and Commercial Bank of China (ICBC) to Wang Pingyan, a coal miner in Shanxi with an annual return of 10%.

Essentially, the higher returns offered by the trust made them an attractive alternative to bank accounts, which normally offer 3% interest on one-year deposits.

In Wang Pingyan’s case the company collapsed in 2012 after the owner was caught illegally collecting deposits.

Fortunately, an unidentified entity stepped in to bail out investors, although not for the full interest.

This was not the first investment product that risked a default and it won’t be the last.

Imagine: over 10 trillion yuan assets are being managed by similar trust companies in China.

Who will get into trouble next?

While the bailout has provided some breathing space for China’s financial sector, an opportunity was missed.

The Wang Pingyan bailout heightens complacency, making stakeholders feel as if someone will always save them eventually.

But China’s financial system is fragile: behind fabulous wealth management products appears to be widespread collusion between trust companies and banks without effective risk control mechanisms.

Following the 2008 global financial crisis, debt levels in China have soared from 130% of GDP to more than 200% today.

Although China’s regulators have been clamping down on shadow banking, much more control is needed.

To be fair, some analysts argue that such concerns are exaggerated as they are based on the assumption that other products will go into default.

Still, there are eerie parallels with what is going on in China now to the US financial services industry pre-2008 crisis.

Malaysia, in particular, will be vulnerable to a Chinese meltdown.

China is a major trading partner.

In fact, about 12.6% of Malaysian total exports went there in 2012.

Hence, a slow down in China will reduce the demand for key products such as electronic components and palm oil, eventually impacting trade balances.

As exports weaken, local production will be affected as well.

This could potentially suppress wages and affect the money cycle.

China matters because a debt crisis there could lead to a slump in Southeast Asia.

The implications for ordinary Malaysians will be severe, struggling as they are with rising costs of living.

I’m thinking about people like Shahrizal, a food stall owner in Temerloh, whom I met while I was shooting my Ceritalah Malaysia documentary (“A quiet Malaysian hero in his own right”, March 6, 2012).

As he told me over the phone recently:

“I can’t say that the price hikes hasn’t impacted my business. With rising costs, the only feasible option for me is to raise the price of our dishes. Of course, some of my customers won’t be too happy with this.”

Sadly, people like Shahrizal are at the mercy of global forces.

A slump would be hard on people like him.

Nobody wants to eat out in a bad economy.

Doesn’t 2014 bring back memories of 2008? Of 1997?


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