Credit in China is expensive and often out of reach of small- and medium-sized companies. The huge growth in shadow banking, or non-bank lending, filled the gap and provided lifelines to smaller companies but analysts agree that it poses threats to the world’s largest economy.
DEALING WITH DEFAULT
In February this year, CITIC Securities, China’s top brokerage said it would seek a legal solution for repayment from a wealth management firm that issue a product that risks default. The high-yielding product, marketed by CITIC, missed a RMB7 million ($1.12 million) payment to investors on 5 February.
RISK & REGULATION
Aiming to rein in the risks associated with shadow banking, the authorities, including State Council, People’s Bank of China, the China Banking Regulatory Commission, Securities Regulatory Commission and Insurance Regulatory Commission have issued a slew of measures. Previous regulations tended to focus on one particular operation but last year, a more systematic approach was taken.
Trust companies – losing faith
Trust companies are one of the most crucial yet controversial components of the shadow banking market. Contrary to their western counterparts, Chinese trust firms engage in private placement investment banking, providing financing to relatively higher risk borrowers funded by high-net-worth individuals (HNWIs) and corporations/institutions (investors). They are also intermediaries, providing a conduit to banks and other financial institutions that are restricted from investing into certain asset classes or launching certain wealth management products.
Trust companies create WMPs, which banks market for them in return for a commission. The risk with these products is that the arrangers don’t hold these loans on their balance sheets or set aside capital against potential defaults. Instead, banks typically extend the facilities via trust companies, which cannot take deposits or formally loan out money, but are allowed to manage the products.
Trust companies raise money from investors, usually high net worth individuals or companies that meet required wealth standards, of several million renminbi in assets. WMPs are attractive, yields are as high as between nine and 12 percent per annum compared to single digit bank deposit rates. Trust companies charge fees of one to two percent of the loan value and so the ultimate borrower pays around 10 to 15 percent, well above the 7-8 percent for bank loans.