China’s shadow banking surfaces

Wenzhou of Zhejiang province is one of the most, if not the most, entrepreneurial places in China.  It also happens to be the place where the shadow banking mess in China is concentrated.  Loan sharks, trusts, and mutual credit guarantees are some of the elements of the informal lending system in China which are all common in Wenzhou.

What is often overlooked is that the shadow banking system and the formal banking system are intricately linked.  To cut a long story short, a lot of funds within the shadow banking system originated from the formal banking system either through banks selling wealth management products to customers or through banks’ off-balance sheet vehicles.  Because these shadow banking activities are not always legal, we knew little about them beyond the existence of formal banking linkage.  Because of these links, it is not hard at all to imagine that risks of a blow-up in the shadow banking system would spread to the formal banking sector.

According to Economic Information, there are signs that troubles within the shadow banking system are starting to surface in formal banking system.  Non-performing loans in Zhejiang banks continued to rise.  Investigations by the regulatory authorities looked at 170 companies which obtained loans from banks, and found that 70% of these companies under investigation had signs of over-capacity, involvement in real estate investment and informal lending, with 90% of loans classified as “bad”.  In fact, non-performing loans have been rising in Wenzhou for 11 consecutive months to RMB4.5 billion, with the NPL ratio at 2.43% at the end of May, and far higher than the national average (if both numbers are to be trusted, of course).

The problem does not look huge at the moment, but it is evidence that risks in the shadow banking are spreading to the formal banking system, slowly but surely.