HONG KONG (Reuters Breakingviews) - Chinese shadow banking is poised for a comeback. GDP grew 6.0% last quarter, but credit growth disappointed as campaigns to cut bad debt while pushing banks to lend to risky small firms resulted in financial muddle. Informal channels are starting to fill some of the gap for healthier parts of the private sector, but at dangerously high rates.
Central bank data shows growth of non-bank lending, like so-called entrusted loans between companies and discounted commercial paper, has declined since 2018. With venture capital and private equity flows sharply down, combined with a crackdown on peer-to-peer lending, bankruptcies have spiked. Last year saw a record for corporate bond defaults.
Alongside the bad-debt clean-up, Beijing has pushed financial institutions to lend to small- and micro-enterprises. That has encouraged banks to plough capital into tiny, risky borrowers, even as they are under the gun to clean up bad loans. Moreover, healthier areas of the economy - stable, boring medium-sized private firms with lots of collateral and employees – have been neglected by formal channels.
A recent survey by China Beige Book suggests a sharp revival in shadow credit in mid-2019, contradicting official data. During the second quarter, the share of non-bank lending surged from 30% at the start of the year to 45% of total loans – the highest on record - and has remained high since. Sources of credit ranged from non-bank state-owned companies, trusts, online services and individuals. In a recent conversation with Breakingviews, one Chinese finance professional admitted to personally lending to small companies, and spoke glowingly of double-digit returns. To compare, the one-year loan prime rate is just 4.15%.
Therein lies the problem. Regulators are trying to bring the cost of credit down, but Beige Book data shows interest rates for small and medium firms shot up 266 basis points quarter-on-quarter in the three months to December. Another headache for officials is that such informal and mostly illegal loans are hidden from them, akin to the “back-alley” lending that fuelled the private economy in the early days of reform. Unsurprising, the alley charges more for risk.
Opacity presents a systemic threat. Having mopped up some of the worst corners of the financial system, and with growth still wobbly, regulators may soon decide shadows aren’t so frightening after all.
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