“If it looks like a duck, quacks like a duck, and acts like a duck, then it is a duck (..) But what about an institution that looks like a bank and acts like a bank? Often it is not a bank — it is a shadow bank.” This is how the concept of ‘shadow banking’ is straightforwardly explained by Laura Kodres in What Is Shadow Banking? The term was first coined in 2007 by economist Paul McCulley at a financial conference.
What does the growth of the free shadow banking market mean in a country that stresses “socialism with Chinese characteristics”? Collier discussed the status quo of shadow banking during a special event at The Bookworm, Beijing, on March 28.
Andrew Collier (@acollier) is an expert in China’s macro economy and the practice of shadow banking. He is the former President of the Bank of China International USA and is a business-focused journalist for, amongst others, the South China Morning Post. His book Shadow Banking and the Rise of Capitalism in China will come out in May 2017.
In simple terms, Andrew Collier explains shadow banking as “capital that is distributed outside the formal banking system” – which can be anything from small-scale lending shops to large-scale trust companies. That they are outside of the “formal” banking system usually means these channels lack a strong safety net and have a different (and lesser) regulatory oversight (Elliott et al 2015).
Although shadow banking only held a fraction of the Chinese economy in the early 2000s, its share in China’s current annual lending is more than substantial (nearly half of all China’s economy annual RMB 25 trillion / $4.1 trillion lending). Risky business? Yes. But since many companies do not have access to formal loans, the practice has become ubiquitous. Some reports also suggest it has an upside as it boosts economic growth by making financial services cheaper and more accessible.
On Sina Weibo, the topic of shadow banking (影子银行) has received a lot of attention lately, with some netizens expressing their worries about the phenomenon: “Shadow banking is becoming a chaos, there is an overflow of people lending money!”
Collier also reinforces this message at The Bookworm, where he shares his experiences with the ‘game’ of shadow banking in China; a messy business where one of the most important questions is: where does the money actually go?
“An enormous miniature park? I saw a lot of odd constructions everywhere – I looked around and I started to become very skeptical.”
Collier’s interest in China’s shadow banking started in the 2000s when he joined the Bank of China and went on many business trips within mainland China, during which he witnessed how huge amounts of money were being pumped into projects that were often dubious; sport stadiums that would only host one sports event in a year, or a miniature theme park spread over several acres of land.
“At the time it looked like a bit of a joke,” Collier says about his visit to the, ironically, enormous miniature theme park located in Sichuan province: “But it was not just this. Some investments might pay off in the end, but you would see a lot of odd constructions everywhere – and I looked around and I started to become very skeptical.”
His ample experience with China’s world of ‘alternative’ banking over the past decades fascinated him so much that he decided to dive into the topic, with the main focus on simply following the money – tracking where it is coming from and where is it going.
But the issue turned out to be not that simple, as many people did not even know what it was they were investing in (“Some kind of bridge somewhere,” one investor once responded to Collier.) Within a few years after Collier’s interest was ignited, the term ‘shadow banking’ first popped up.
“What actually is ‘shadow banking’?”, Collier wondered, and asked himself: “Is it a good or a bad thing for China?”
It turns out that a lot of the important data about shadow banking is simply not there. What ‘shadow banking’ actually means also strongly varies per country and system.
Collier stresses that what is now happening within China is not really the same as what happened at Wall Street in the 1990s, when there were huge amounts of retirement money in the financial system and banks took bad property loans and “put lipstick on a pig” in selling their mortgage products.
Despite all the lingering questions, one thing is crystal clear: shadow banking is big in the People’s Republic of China (PRC). Even if China’s leadership would not necessarily call it ‘capitalism’ (rather: “capitalism with Chinese characteristics”), Collier wonders if shadow banking is the tail that’s gonna wag the dog, with many things happening that might be dangerous for the Chinese economy.
“Few people actually know where the money goes and nobody cares. They’re taking a slice of something and have no idea what it means.”
So what is actually happening in China, if it is not the “putting lipstick on pigs” phenomenon of 1990s Wall Street? After China’s 2008/2009 economic stimulus, there has been a lot of money flowing through the system. But China’s ‘shadow banking’ was not necessarily a result of that, Collier argues, as it was going on ever since he first lived in China in the 1980s and saw how people were borrowing money from friends and relatives for grain and cotton – actually also a form of shadow banking.
Throughout the years, especially over the past decade, China has seen a huge growth of non-state lending from ‘mom and pop loans’ to huge state-owned bank trusts. It is a problem that mainly stems from a system that was not designed to handle so much cash and was under very limited control.
Collier explains shadow banking as an overflow of water that is trying to find new channels within the PRC, with capital flows going outside of the banking system – through land sales or by borrowing from private markets. Non-bank channels don’t only have lower requirements for capital and liquidity, they also do not have the same low limits on interest rates as formal banks.
In the 1998-2012 period, shadow banking had actually become so big that there was an 18 trillion RMB gap in local government revenues, of which shadow banking was a large part: “Basically it is an unsustainable financial system,” Collier says, with institutions scrambling to either lend the money or to receive it.
According to Collier, there are two main actors that play the main role in the shadow banking ‘game’; Trusts and Wealth Management Products (WMP). WMP are uninsured financial products that often have a high rate of interest. Trusts are basically “banks in disguise with hardly any regulatory oversight,” as Collier says.
“They are, in fact, regulated – but so lightly that western observers will call them shadow banks. They tend to have government (provincial) ownership, and have trillions of outstanding loans.”
Some years ago Collier met with a person from a renowned oil company, who said his job was “managing money.” Upon further talking, Collier realized this person was managing billions and was basically running his own bank; a new reality in present-day China.
A big problem that Collier repeats throughout his talk is that it is not just that important data is missing on shadow banking in China, or that few people actually know where the money goes, but that “nobody cares and everyone thinks it’s all fine; they’re taking a slice of something and have no idea what it means.”
“Socialism has become nothing more but a national ideology.”
Collier stresses that China’s shadow banking is all about different actors who are halfway in the middle: it is not about state versus private. In China, it is all about partly state-owned parties versus partly private actors.
The upcoming book and Collier’s Bookworm talk come at a time when China is cracking down on shadow banking.
The crackdown is part of the balance that is kept on shadow banking within China, as the central bank of the PRC does not want pressures to get out of control and attempts to minimize risks.
Experts tell Bloomberg that there is a possibility that the People’s Bank of China (PBOC) will directly inject funds into smaller banks if cash shortage continues.
When Collier asks the audience at The Bookworm to raise their hand if they think the system is going to collapse within the coming 5 years, nobody raises their hand. Apparently, many people don’t worry too much about the negative effects of shadow banking on China’s financial system in the years to come.
On Weibo, many netizens are more skeptical, not just because of the risks involved in shadow banking, but also of what it means in China today.
One commenter says: “In fact, China is not socialist at all when it comes to economics. Right now, it is actually a capitalist country – socialism has become nothing more than a national ideology.”
Sources and further reading
Collier, Andrew. 2017. “Shadow Banking and the Rise of Capitalism in China.” Palgrave Macmillan.
Elliott, Douglas, Arthur Kroeber and Yu Qiao. 2015. “Shadow Banking in China: a Primer.” Economic Studies, the Brookings Institution.
Kodres, Laura E. 2013. “What Is Shadow Banking?” International Monetary Fund (50/2): June https://www.springer.com/us/book/9789811029950#aboutBook [28.3.17].
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