How to Reduce the Risk of China’s Shadow Banking
June 1, 2014

The problems of China’s shadow banking industry have been repeatedly pointed out over the last few years. According to the Dean’s Distinguished Chair Professor of Finance at CKGSB, Ou-Yang Hui, the answer lies in accelerating the diversification of the capital market, as well as expanded government-led financial reform.

In an interview with Fortune Korea, CKGSB Professor Ou-Yang Hui said “the wealth management products related to shadow banking in China account for a relatively small portion of China’s total banking assets”, adding that China’s shadow banking situation is still under control. The fact that Chinese banks have their loan deposit ratio capped at 75% would appear to support Professor Ou-Yang’s claim. He further explained that China’s shadow banking industry now equals 40% of the country’s overall GDP and is worth over RMB 27 trillion – still lower than that of the UK (480%) and the U.S. (160%).

However, he admitted that the rapid rise of China’s shadow banking over the last few years is cause for concern. He said this stems from “a strong loan demand from corporations due to relatively low real borrowing rates compared to nominal GDP growth rates, especially from private companies and SMEs, that could not be satisfied by the formal banking system because of loan quotas or sector loan regulations.”

Nevertheless, the reason that he says the situation is under control is because China has a different loan-lending structure from that of America or Europe. He explained that “compared to the complicated structural products that contributed to the financial crisis in 2008, the wealth management products related to shadow banking in China are relatively simple. In addition, China’s shadow banking is mainly exposed to corporate credit and has little exposure to household credit, while a significant amount of US securitization products and related structural products are based on mortgages and other consumer credit such as credit card receivables. As a result, it is unlikely that there will be the same widespread individual defaults that caused the US financial crisis. Since the majority of major corporations are state owned, even if there are troubles, the central government is likely to bail them out.”

As a remedy to normalize China’s shadow banking sector, Professor Ou-Yang advised institutional investors to develop bond markets, gradually replacing wealth management products and trust products. He also suggested banks should fully disclose their underlying credit risks to investors. This means that the government should accelerate financial reform to enhance financial transparency and diversify the capital market.

Read “How to Reduce the Risk of China’s Shadow Banking” on Fortune Korea website.

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