The term "shadow banking," which was created in America in 2007, is used to designate financial services which are not subject to official oversight within the banking system.China's property market, which is estimated to account for a quarter of the country's economy, is closely linked to shadow banking, counterparts to local government finances, and individual wealth.Right now, Beijing faces the challenge of controlling the shadow banking and debt from real estate developers while providing other forms of economic aid.
Attention to China's real estate issues has once again raised concerns regarding the realm of shadow banking and the hazards it might present to the economy.The term "shadow banking" was first used in the U.S. in 2007 and refers to financial services provided outside the framework of the regulated formal banking system.As opposed to traditional banks, institutions operating in shadow banking can grant loans to a larger number of borrowers without such lower levels of guarantee, meaning a sudden and abrupt request for repayment would have a successive effect.Furthermore, because of the lack of regulatory supervision in shadow banking, it is difficult to determine the size of the debt and the hazards it could bring to the economy.In response to the speedy growth of non-bank debt, the Chinese government has attempted to limit it over the last couple of years.
The strength of the state's influence has made the country's circumstances unique.The banking system is largely controlled by the state, meaning it is more difficult for non-government-owned enterprises to receive financing from traditional banking companies.When engaging in financial transactions, people accepted that the state would always come to the rescue if anything were to occur, as there was an understanding in place that the state would be there to bail out anyone in a pinch; this is referred to as an implicit assurance.The amount of money involved in China's shadow banking system is not accurately known, but the Values have been estimated to be in the trillions of U.S. dollars.
Approximately one quarter of China's economy is comprised of the real estate industry, at the crossroads of household assets, local authorities' finances and the shadow banking system. Individuals in China hastened to capitalize on this opening, either by purchasing a home or speculating on properties, as rates during the last two decades skyrocketed. Local governments were also keen on the revenue from land sales and the boom of their regional economy.
Logan Wright, the Trustee Chair in Chinese Business and Economics at the Center for Strategic and International Studies, outlined in an April report that developers were allowed to draw extensively from shadow banks, avoiding limitations on borrowing for land acquisitions. This caused land costs to continue increasing, with developers responding by increasing housing expenses to preserve profits. Wright argued that Beijing's current regulations on shadow banking led developers to look for other means of lending to pay off their preexisting shadow banking loans. He indicated that this implied developers began relying more heavily on the presales of apartments to purchasers --using mortgages-- and reducing construction to economize.
In August 2020, the government put a halt to additional development by setting restrictions on levels of debt. This was due to the fact that major real estate companies like Country Garden and Evergrande, which had seen strong growth over many years, had become unable to sustain their cash flow as a result of declining home sales. Almost at the same time, news came out that Zhongrong Trust was having difficulty refunding its investors from some of its investments, mostly given to developers.
It's becoming increasingly evident that some of the real estate companies facing hardships had kept some debt hidden. In late August, S&P Global Ratings mentioned that this matter raised questions regarding the loose controls and bold accounting operations in developers during their prosperous times. Shimao, a property developer, exposed this summer that the quantity of debt it held was much higher than previously stated, without PwC, their former auditor, being aware of it. As a consequence, PwC discontinued being Shimao's auditor in March 2022. Edward Chan, a director at S&P Global Ratings, expressed to CNBC in a phone conversation that "some of those funds, those hidden debt were provided by the trust companies. These trust companies were basically a part of China's shadow banking system".
Trust funds in China generally target wealthier households when selling investment products. As of the end of March, an estimated 1.13 trillion yuan ($159.15 billion) or 7.4% of the their value was attributed to real estate, according to the China Trustee Associations data used by Nomura. The Nomura report suggests that trust companies' investments in the property sector is actually 3.8 trillion yuan (as of June) which is more than three times the previously reported figure. The report went on to suggest that some of these trust products may have failed to disclose or deliberately concealed key information about their funds as a way of side-stepping financial regulations.
In China, banks have taken advantage of trust companies to disguise the amount of risk they carry in their balance sheets and make profits by giving loans to restricted borrowers, like property developers and local governments, said Wright from CSIS. His estimate was that from 2012 to 2016, shadow banking accounted for almost one-third of the credit in China, and after the Beijing government's attempts to regulate it, credit growth was cut in half. At present, Beijing needs to balance its actions to reduce shadow banking and debt owed by real estate developers with other economic boosters.
Wright commented that the deleveraging campaign implemented by China's leadership in 2016 is the root cause of the structural economic slowdown. He continued that the success of shifting resources away from property-related lending and local government investment projects to more productive private sector firms will determine how China's economy will perform in the next 5 to 10 years. If the process is not managed properly, he suggested that growth could drop to as low as 2 percent in a decade's time.
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