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Shadow banks the biggest danger for Chinese economy

By Reporter
 — 1 minute read

China's growth rate is likely to stay low, and the country may even slip into recession, according to an academic from UNSW Business School.

Chinese annual growth slipped to 6.2 per cent in the second quarter, the country’s weakest expansion in nearly three decades. 

“One of the headline reasons is [President Donald] Trump’s tariff war and other actions to limit China's Belt and Road policies that have had a dampening effect upon the Chinese economy,” said Vic Edwards, a visiting fellow in the school of banking and finance at UNSW Business School. "But the biggest danger comes from ‘shadow banks’ also known as underground banks.”


Mr Edwards argues that China has a serious problem in not being able to finance the growth of its private sector as about 70 per cent of all government funds have gone to SOEs with the result that private enterprise in China is being starved of funds. Private companies in need of funds have been prepared to pay 15 per cent to 25 per cent interest to the “shadow banks” consisting of very wealthy entrepreneurs and private capital providers, located mainly in the Wenzhou and Ningpo regions.

According to the World Bank and BIS Oxford Economics, the shadow banks have also attracted funds from government-sourced banks and now provide roughly 30 per cent of all capital in China. 

“The shadow banks therefore cause a fundamental weakness and fragility in China’s capital market and may cause China’s market to collapse if not controlled. These shadow banks are relatively unregulated and provide the greatest risk of China falling into a recession in the next two or three years if not controlled and corrected,” Mr Edwards said.

“[Former] President Wen Jiabao asked the China Banking Regulatory Authority to try to closely regulate the shadow banks in 2011 but this only lasted for about two years.

“Now, the shadow bankers have taken over again and family members of borrowers who default can be kidnapped and never seen again.”

A further downward pressure on China's growth rate has been the Chinese government's attempts to close down or sell off “zombie” unprofitable government entities.

“Bankruptcy laws were enacted in 2007 but not enforced by the judiciary using a process called chongzu which rescues the firm,” Edwards says. “Proposals are underway now at all levels in the Chinese government to have effective bankruptcy laws so that many inefficient SOEs can be taken off the government's funding provisions – but that might cause unemployment levels to rise, which was previously unheard of in China.”

China has also switched from being an export-oriented economy to consumption-oriented in 2016.

“High rates of growth, such as 12 per cent, are associated with being an export economy but rates of only between 6 per cent and 7 per cent are associated with a consumption-based economy. Growth rates could fall further, and China may fall into recession,” Mr Edwards said.

Shadow banks the biggest danger for Chinese economy

China's growth rate is likely to stay low, and the country may even slip into recession, according to an academic from UNSW Business School.

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