Risk Analysis Firm Casts Nervous Glance At China's Shadow Banking System

Tom Burroughes

14 February 2014

The recent-near default of a Chinese wealth management product, and the technical default of another, must alert the industry to how vulnerable it is to systemic failures, according to a report by IHS Country Risk, a firm tracking geopolitical and other risks.

The report, Shadow banking in China and recent near-default case: Missed opportunity or averted disaster? Argue that the proliferation of “shadow banking” activities in the world’s second largest economy continues to pose systemic risk and should and likely will be a political priority this year.

The report comes in the wake of a move by China’s Industrial & Commercial Bank of China, which had sold a RMB3.0 billion trust product, came close to defaulting on 31 January. China Credit Trust said it reached an agreement on a potential investment in the high-yield product (see here).

For some time, there have been fears that in parallel to China’s state-owned banking system, a parallel, “shadow” regime, with lax controls and lack of transparency, has developed to meet demand for higher-yielding products. There have been calls for reform.

“We view these events as a missed opportunity to restrain a prominent moral hazard and to bring shadow banking under greater control,” IHS said in its report.

Among its conclusions, the report said the rescue of the China Credit Trust fund is at odds with the Chinese authorities’ recently declared preference to give market forces more sway in the economy.

“While recognising some justifications for the bailout, including higher pre-holiday market volatility and the pending release of new shadow banking regulations, IHS considers this event a missed opportunity for the authorities to have shown clear commitment to restraining a prominent moral hazard and bringing shadow banking under greater control,” it said.

The report noted that last week, a RMB289-million ($48-million) tranche of an investment product issued by one of China's trust corporations, Jilin Province Trust Co, technically defaulted. JPT is looking for ways to recover funds for its private investors.