Shadow bank activities may spark crisis

The rapid growth of China's shadow banking - crossing many sectors and taking in banking, trusts, securities and insurance - may spread risks quickly from the money market to the real economy and trigger a systemic financial crisis, a report on financial regulation (Annual Report on China's Financial Supervision and Regulation (2014)) said.

Non-traditional financing directly involves a total of 36 trillion yuan ($5.85 trillion) of assets in China, according to a report, released on Friday, by the Institute of Finance and Banking at the Chinese Academy of Social Sciences.

Interbank business is the critical link. Once the risks with shadow banking become real problems in the interbank market, banks and other financial institutions may face a liquidity drought, bringing defaults and a credit crisis in its wake.
"As the interbank business is expanding quickly, financial risks become more contagious within the banking system," the institute said. "Regulators should attach great importance to the supervision of interbank business."

By the narrowest definition, China's shadow banking, which includes private lending, third-party wealth management, peer-to-peer lending, micro loans and financing guarantees, is capable of handling 6 trillion yuan of business despite authorities' tightened oversight in the last couple of years.

The figures are estimates due to statistical limitations and double counting in the calculation process.

The government should guide interbank business development by strengthening risk management and forming a multi-layer financial market with a diversified financing system, research fellows at the Chinese Academy of Social Sciences suggested.

It should improve interbank standardization and transparency and require banks to provision against possible risks from interbank business, the fellows said. The current financial, statistical and accounting systems needs improving to accurately reflect credit expansion at commercial banks, they said.

Faced with the combined pressures of interest rate liberalization and Internet finance, China will have to keep adjusting its banking regulatory polices to handle off-balance-sheet, cross-border and cross-sector risks and improve the banks' management skills, the report said.

Regulators should also experiment with allowing private capital to establish banks at its own risk and continue deepening institutional reforms of the banking sector, it said.