Analysts have been warning on the risks of China’s “shadow banking” system – a sector estimated to have as much as RM4.15tril in assets.
RAMADAN is always a good time for reflection.
This year, I’ve been researching a new TV documentary series, Ceritalah Indonesia, that I’m hoping to shoot by September.
I want to tell the story of how Indonesia, having endured the Asian Financial Crisis in 1997/1998, ousted President Suharto and then launched into the tumultuous “Reformasi Era” before finding some degree of stability under President Susilo Bambang Yudhoyono.
As a result, I’ve been going over recent history – including the roots of the crisis itself.
Now even though I’m not an economist, it’s been a very interesting journey, especially reading about the various bank failures that sparked off and then deepened the crisis.
Back then, banks seemed to be falling like dominoes: Thailand’s Finance One collapsed spectacularly.
This was followed only a few months later by Bank Indonesia’s surprise decision to close sixteen banks.
As the momentum gathered in intensity, one of Japan’s most important brokerage houses – Sanyo Securities was also shuttered.
Just over a decade later, a similar sequence of events was to take place in Europe and North America as Northern Rock, Iceland’s Landsbanki (better known by its British brand-name Icesave) and Lehman Brothers also failed, leaving in their wake a massive dislocation across the developed world.
Now, as I reflect on the events of 1998 and 2008, I can’t help but sense a similar trend emerging to our north – in China.
Indeed, the next global economic crisis could very well start there. Why?
Well, have you visited the many ghostly, almost totally-empty high-rise communities that have sprung up across the Middle Kingdom?
I can still recall wandering through vast and deserted business quarters in Dalian, Tianjin and Beijing.
At the time, everyone told me that China was different ... well that’s what they said about Thailand, Iceland and Spain.
But now after years of over-building: roads, bridges and railway lines, expanding capacity to the highest degree, people are beginning to question China’s growth model.
For many months now, analysts have been warning on the risks of China’s “shadow banking” system – a sector which some estimate to have as much as US$1.3tril (RM4.15tril) in assets.
“Shadow banking”– is simply non-bank lending and borrowing. Investing in hedge funds, venture capital and private equity are all forms of “shadow banking”.
There’s nothing wrong with this: shadow banking often helps individuals or businesses that would otherwise not qualify for conventional bank loans or get credit.
Also, some shadow banking wealth management products offer lucrative returns.
Shadow banking thrived in China with the liquidity that flooded the market in 2008, when its government pumped in a US$586bil (RM1,828bil) stimulus package in response to the subprime crisis.
All this excess liquidity has, however, causing a housing bubble and also saved a number of underperforming Chinese state-owned enterprises from having to reform.
At the same time, Chinese policymakers were debating long-standing calls for them to cool down their economy – a fateful decision as we will see later.
As the astute Henny Sender wrote in the Financial Times on July 11, the investment products which form the backbone of Chinese “shadow banking” have the potential to create yet another subprime crisis.
Why? Well, many of China’s hedge funds are shorting the shares of China’s weaker banks. Does that sound familiar?
According to Sender: “… second-tier banks listed in Hong Kong or in mainland China, including China Merchants, China Minsheng Banking and tiny Huaxia, are vulnerable” as they “… have less ability to absorb losses and more of their balance sheets are tied up with shadow-like activities.”
Minsheng, founded in 1996, is China’s ninth-largest bank by assets and the only private bank amongst its top 10 commercial lenders.
It also, according to JP Morgan, has the fastest growth in inter-bank assets and the highest weighting of interbank liabilities to total interest bearing liabilities.
As mentioned, China’s government was initially determined to “cool” its economy.
The People’s Bank of China (PBOC) hence refused to intervene when the Shanghai interbank offered rate (“Shibor”, China’s LIBOR) spiked to an all-time high, to almost 14% from 3% previously.
This led to fears that the sudden “credit crunch” would leave banks like Minsheng at risk of default, the very thing that caused the collapse of Western banks like Lehman in 2008 due to a sudden lack of liquidity.
Indeed, in late June worried investors sent Minsheng’s shares down by 16.7%, wiping out US$6bil (RM18.7bil) of its market value.
Talk of a crisis forced the PBOC to promise to end the credit crunch.
Still, worries over China’s shadow banking system persist.
As Fitch Ratings has stressed, systemic risk over China’s mid-tier banks is rising due to their credit exposure and weakness in absorbing losses.
It remains to be seen whether banks like Minsheng will indeed become China’s Lehman.
But this much is clear: those who ignore history are doomed to repeat it.
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