BNP Paribas: Chinas systemische Risiken

We define shadow banking in China as non-bank financial activity, including trust loans, wealth management products (WMPs), company-to-company entrusted loans, money market funds (MMFs), banker acceptance bills and curb market (or underground) financing. It is a double-edged sword. On one hand, shadow banking is interest rate liberalisation by stealth, facilitating China to exit financial repression. On the other hand, it increases systemic risk as it is not yet properly regulated and suffers from adverse selection.

Rising systemic risk

The local banks’ cosy relationship with, and presumably large exposure to, shadow banking has aggravated systemic risk, despite increasing regulatory control since 2011 on banks’ cooperation with and exposure to the trust sector and WMPs. Typically, banks package their loans into WMPs and sell them to retail clients, thus taking these loans off their balance sheets and relaxing their regulatory loan constraint. The proceeds are channelled to trust companies which, in turn, invest the funds either back in the banks’ loan assets or other assets, including local government debt instruments. Trust companies also issue WMPs themselves.

If defaults were to occur in the shadow banking market, banks would not be able to expand their balance sheets at will to offset the contraction of shadow bank credit. This is because banks are restricted by regulations, including their loan-to-deposit ratio, loan quotas, reserve requirements and administrative lending restrictions. Due to the close bank-shadow-bank relationship, banks’ asset quality would deteriorate and they would suffer losses as they put the off-balance sheet assets back onto their balance sheets.

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