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China’s Next Crisis Lurks in Shadow Banking

As with most of the world economies, China is dealing with a growing debt problem, but the continuing use of shadow banking is causing more harm than good. Over the past few years the number of unregulated loans, investments, and financial products, has doubled. The value of this so called shadow banking industry is expanding and currently sits around 70 percent of China’s total GDP upwards of 35 trillion yuan.

There are several risks that this form of banking carries and the question that most economists and analysts are wonder is, how much of this capital must be covered by the national government. As the economy slows and businesses and local governments still have debt obligations many of them turn to shadow banking, with sometime exorbitant interest rates, to service their prior debt payments. The official debt numbers of the various government departments sits around 30 percent of total GDP, but many analysts estimate that the true debt rate of governments, consumer, and corporations exceeds 200 percent of GDP.

With no plan of action to remedy this problem, it is likely to get worse before it gets any better. The shadow banking industry is involved in all aspects of corporate, consumer, and government, from prestigious securities firms to individuals at pawn shops. The shadow banking establishments are designed to offer borrowing and investment funds to people or organizations that want to circumvent the debt quotas or interest rate caps, because they are in dire need for the funds. The development and reliance on trusts has created organizations that are able to lend money out at rates of interest that exceed reasonable and official rates so that corporations can survive a little while longer.

While the trusts usually make great returns for their investors, this profiteering is leading to a destabilization of the local economies. Local governments and corporations that need to get things done without all of the red tape that is associated with obtaining bank funds. While this is great for speed of business, the due diligence required to ensure that the organizations have the capacity to repay the loan is often overlooked, which can lead to investments by the shadow financing organizations that aren’t able to be repaid.

The Chinese government is aware that this is occurring and although they do want to get it more under control they understand it’s importance for various businesses and the support of local governments. It will take major policy reform and enforcement to reverse this trend, and it doesn’t look like China is taking the necessary action steps to remedy this problem any time soon. While the official debt numbers sit around 30 percent of GDP, the overall debt from the shadow banking is more likely around 200 percent of GDP and growing, which mean that crisis is just around the corner.

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