China’s Banking System Springing Leaks All Over

Take your pick. Either story shows the deep stress in China’s banking system at a time when China’s economy is already slowing.

Story 1: After trying to regulate the Peer to Peer lending industry, Beijing has decided to shut down most of the $176 billion market, according to Bloomberg. Small and medium-size Peer to Peer lending platforms will be wound down, while large ones will probably be asked to rein in lending. At its peak, loans through these loosely regulated platforms accounted for more than 10% of all consumer credit. The number of lenders peaked at 5,000 in early 2016–other sources say 7,000 platforms–with outstanding loans of 1.4 trillion yuan ($200 billion.)

Which became a problem when the Chinese economy started to slow and borrowers couldn’t repay their loans, the value of collateral fell, and lax lending standards made it difficult to trace which parties were actually on the hook for the loans.

The Peer to Peer platforms had attached money from individuals by promising them extremely high yields–and then charging even higher rates to borrowers who were having trouble getting bank loans.

Can you say “Subprime lending crisis”? By July 2018 4,740 Peer to Peer lenders had collapsed or been shut down. And now Chinese regulators are going to shutdown most of what remains of the sector.

Story 2: On Friday, for a 26th straight season, the People’s Bank of China did NOT inject liquidity into the banking system through reverse-repurchase operations. That’s the longest run since the bank began such daily operations in 2016. And given the slowdown in the Chinese economy, the failure of the central bank to inject more liquidity into the system is extraordinary. And worrying. Because the People’s Bank has apparently decided that with banks reluctant to extend new loans, adding more money to the system just give banks more cash to put into money markets and, more troublingly, speculative investments. In a classic “pushing on the string” scenario, adding more cash to the banking system isn’t likely to benefit the real economy.

The big danger is that any new money–under these circumstances–would wind up in China’s shadow banking system–in risky off-the-books loans. The shadow banking system is estimated to hold 30 trillion yuan in shadow credit. That’s up from 25 trillion yuan in 2016 inspite of new regulations designed to shrink the sector. The 30 trillion yuan of assets (and remember in banking an “asset” is a loan) in the shadow banking system is comparatively small compared to 250 trillion yuan ($35.9 trillion) in loans, according to Goldman Sachs, in the banking system. But the shadow banking system is relatively unregulated and rife with interlocking loan arrangements that make it very hard to tell who is the creditor of last resort. Which makes the sector inordinately risky for its size.

Consider all this background to the U.S.-China trade war and an explanation for why even a slight dip in the growth rate for China’s economy is such a danger–to China and the global economy.

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