Shadow Banking Could Set Off Financial Crisis


A leading domestic expert on China’s financial system says that shadow banking remains a keen source of potential crisis.

At the release of Tsinghua University’s  “2017 China Systemic Financial Risk Q1 Report” over the weekend, several leading experts weighed in on the potential impact of shadow banking upon Chinese financial risk, including Zhu Min, former vice-director of the IMF and head of Tsinghua University’s Wudaokou Financial School; Zhou Hao, vice-head of the Tsinghua Wudaokou Finanical School,  Li Yang, vice-head of the China Academy of Social Sciences, and Gao Shanwen, chief economist of Essence Securities.

The general consensus was that despite improvements to economic conditions during the first quarter of this year, real estate bubbles, local government debt and shadow banking all remain severe problems fr the Chinese financial system from a risk perspective.

Gao Shanwen pointed in particular to the potential for China’s shadow banking sector to be the trigger point for financial crisis.

“In future a crisis in China’s financial system isn’t likely to [start] with securities companies or trust companies, and even less likely to be start  on the balance sheets of banks. A crisis caused by severe asset losses will definitely [start] with shadow banking,” said Gao.

“The level of chaos in shadow banking, the level of leverage, the allocation of maturities and the risk that it brings has not been well reflected by pricing on the stock market.

“These issues are actually our most urgent problem at present.”

According to Gao the chain of transmission for severe or fatal financial crises throughout history hasn’t been cyclical macroeconomic fluctuations which are predictable, but other factors which are latent, opaque or difficult to predict.

The shadow banking sector is precisely one such factor, with Gao noting that the 2007 financial crisis in the United States was caused by massive and unregulated lending activity.

In China’s case, Gao argues that there is not much authentic shadow banking in terms of the conventional definition used overseas, which refers to unregulated lending and credit extension activities undertaken by non-bank financial institutions.

Instead, “Chinese shadow banking is the term for the shadow cast by banks, performing traditional banking operations to achieve the goal of regulatory arbitrage.”

Gao notes that regulators have recently adopted rigorous measures to deleverage China’s shadow banking sector, as evidence by the heavy stresses on financial markets.

The Shanghai Stock Index has opened low for 19 days in succession, while yields on the Chinese bonds are breaching new highs, and financial markets are suffering from a severe lack of liquidity.