Text size

Financial market’s attention seems to have returned to China’s shadow banking risk again recently.

Sensational media headlines to reports about Chinese shadow banks writing an open letter to the top party officials in Hebei province asking for a bailout, China’s banks looking for growth by engaging shadow banking activities, and shadow banking killing China’s stock market1 are raising market concerns.

The common denominator here is the perception that China’s shadow banking problem poses a global systemic risk. However, international data shows clearly that shadow banking risk involves mainly the large developed economies.

Chi Lo

Shadow banks, including those in China, perform similar functions and have similar risks to traditional banks but operate outside the formal banking sector and with less regulatory oversight. They also lack public deposit insurance and lender-of-last-resort facilities from central banks.

China’s shadow banking market began to grow rapidly during the Global Financial Crisis in 2008-09, when Beijing launched its massive RMB4 trillion (USD586 billion) stimulus programme. The stimulus supported Chinese and global growth for several years, but pressures also mounted and pushed Chinese businesses and local governments towards shadow bank funding.

Since President Xi Jinping took charge in 2013, deleveraging has surpassed debt-fuelled growth as the top policy priority, with the People’s Bank of China repeatedly refusing to go back to the old model of wholesale liquidity bailout of the economy. Instead, the central bank began to scrutinise shadow banks’ lending practices and their relationship with the official banking sector, and put in new measures to rein in shadow banking activities.

As a result, China’s shadow banking market has shrunk since 2013 (Chart 1). Also thanks to Beijing’s low debt-to-GDP ratio (of about 33%, including both central and local government debt), the authorities should have the fiscal capacity to deal with any potential crisis.

Recent data from the Financial Stability Board (FSB)3 shows that the global shadow banking risk has not improved since the Global Financial Crisis, with the average shadow-banking-to-GDP ratio rising from 55% in 2012 to 59% in 2014 and emerging markets, including China, showing the most rapid increase.

However, the emerging markets’ expansion comes from a small base and also reflects the relatively faster growth of these economies in comparison with their developed market peers. The size of China’s shadow banking market (estimated at between 35% and 68% of 2014 GDP) is far from alarming when compared to the major economies (Chart 2).

The FSB’s research shows that certain kinds of credit intermediation are more susceptible to runs (for example money market funds, hedge funds and other investment funds), and that the global shadow banking activities that may pose financial stability risks amounted to USD36 trillion in 2014.

It also shows that the largest shadow-banking sectors in the major advanced economies account for almost 80% of the world total, with the US accounting for 40%, Europe’s core economies 21%, the UK 11% and Japan 7%. In contrast, the share of emerging economies is only 8% of the total, although half of this accrues to China.

While international attention has been focused on China’s shadow banking, the truth is that its global share is only one-tenth that of the US and a fifth of its counterpart in Europe, according to the FSB. True, China’s shadow banking has grown rapidly, but from a very low base in international terms. And Beijing is aware of the problem and started to address it in 2013, which should make China’s shadow banking risk manageable.

So the question is why shadow banking in the developed economies is not causing as much, if not more, concern as it is in China and the emerging markets?

Chi Lo, Senior Economist, BNP Paribas Investment Partners (Asia) Ltd. (BNPP IP), and author of “The Renminbi Rises: Myths, Hypes and Realities of RMB Internationalisation and Reforms in the Post-Crisis World”

To be considered for this feature, please submit material to:

Email: asiaresearch@barrons.com