Business Insider - Jim Edwards - 23 November 2016
China's banks are disguising bad debts by turning them into "securitized packages" rather than writing them down as non-performing loans, according to the IMF.
The "untradeable debt" comes from China's "shadow credit" world, which has generated a massive amount of credit that has the potential to become suddenly illiquid.
The debts consist of interbank loans in "a structure potentially susceptible to rapid risk transmission and destabilizing liquidity events," the IMF says.
The amount of "shadow credit" grew 48% in 2015, to RMB 40 trillion (£470 billion or $580 billion), the IMF says, "equivalent to 40% of banks’ corporate loans and 58% of GDP."
If any of this sounds familiar, that's because it is. It's similar in principal to the way American banks disguised bad mortgages inside securitized packages before the Great Financial Crisis of 2007-2008.
Back then, US mortgage providers gave out too many loans to people who couldn't repay them. On its own, that should not have been a problem. A mortgage default only hurts the bank that made the loan. But banks bundled together packages of those mortgages and sold them as "mortgage-backed securities" to other institutions.
Bad mortgages were mixed in with good ones, making it impossible for investors to judge their quality. When it became obvious that some of these packages were toxic, no one wanted to buyany them. The market became suddenly illiquid. And the credit derivative hedges and leveraged bets layered upon them magnified the problem throughout the entire banking system, creating the financial collapse that plunged most of the world into recession.
In China, a number of smaller banks are now trying to do the same thing.
"China’s financial system could be vulnerable to a Lehman Brothers-style collapse," the FT says. The FT's article is based on this report from the IMF, published in August.
Normally, banks get their funding for loans from customers' retail deposits. This is a stable source of funds because people rarely close or move their bank accounts, and their salaries are often deposited directly into them on a regular basis. The funding is "sticky," as the FT describes it.
But some Chinese banks have been generating funds from "interbank loans" and "wealth management products" (WMPs). The latter consist of funds that come from the "shadow credit" world — "nonbank institutions such as trusts, securities companies and fund management companies," as the FT describes it.
The funds are turned into loans. The loans are packaged as WMPs, which look similar to cash deposit saving vehicles. Customers who buy WMPs get higher interest returns, as much 11‒14% (compared to 3% or 4% on regular bonds).
These charts show how they have increased in the last couple of years: