Is Chinese Shadow Lending A Problem?

The charcoal smeared faces of generations huddled around communal chimneys has given way to a diligent youth globe trotting with the promise of economic opportunity unparalleled  since the expansive growth of the American baby-boomer. The shimmering lights of Shanghai shine outwardly despite a nationalist protectionism that, of course, only the Chinese-themselves can enjoy. It’s an economic system that plays the world very effectively even if its internal logic is stunted by state control. However, according to The Economist, China needs financial reform and it is edging or leaning towards reform but ever so slowly. 

In the interim of further liberalisation, there has been a large increase in the number of bad loans by banks in China where the investments are failing at a higher rate. The debt to GDP has increased to 260% against Chinese GDP in the past 5 years and the solution is now to engage in shadow lending products which are difficult to liquidate during a downturn but are currently working to support bank profitability. Shadow lending investments is interesting because it’s difficult to know what is inside these shadow lending products. Bad lending by Chinese banks have pushed them into this more risky territory. Most bankers do not know what is in the shadow lending products. So what? A problem will arise if this shadow lending is impacted by a recession. However, The Economist story is an old repeated narrative where each week they try to engage readers with the thought of economic calamity centred on China.

Isn’t in the case that the political control of banking means bad lending is underwritten by an interventionist state? The risk will be redistributed in the form of bailouts surely. Also, from a western perspective, since the inbound and outbound investment by Chinese banks as so small any economic downturn is unlikely to have devastating effects on the global economy. The total banking sector valuation in China is $40 Trillion USD or 40% of the entire world GDP….the west waits in the wings to gain more access to this relatively low risk market. It will probably not happen with the current political structure, i.e. reforms will have to be in the interest of the Politburo….