Shadow banking: risks lurk in the murk

CHINESE lenders have been criticized for using a shadow banking system to move sour assets off their balance sheets, thereby creating potential risk for the nation's financial system.

In developed countries, shadow banking usually refers to unregulated non-bank financial entities, such as hedge funds, money market funds and other structured investment vehicles that provide services akin to commercial banking.

In China, the landscape looks a bit different.

Xiao Gang, chairman of the Bank of China, the nation's biggest foreign-exchange bank, said the shadow banking system here includes trust companies, small loan companies, underground lenders and even pawnshops. "But basically it involves a liaison between banks and trust companies and private lending," Xiao told the Davos Forum earlier this year.

He wrote a commentary last month urging action to tackle shadow banking, arguing that short-term investment vehicles, known as wealth management products, pose systematic and regional risks to the financial system.

The bank-trust system involves four parties: the bank, the trust company, investors and borrowers. In branches and online, banks sell wealth management products to investors offering higher returns than traditional bank deposits. The money they collect is entrusted to trust companies to fund property and infrastructure projects that may have problems getting normal bank loans.

By July 2010, the bank-trust system involved more than 2 trillion yuan (US$318.5 billion), causing headaches for national credit controls. The China Banking Regulatory Commission subsequently introduced a series of measures to rein in the system in a bid to prevent the commercial banks from hiding credit risks off their books.

According to the latest report published by China Ping An Trust Co, wealth management products issued by the banks reached 4.6 trillion yuan by the end of last year.

Some analysts praised shadow banking for helping businesses in need of more liquidity.

"Shadow banking, such as the trust loan, plays a critical role in social financing in China," senior Datong Securities analyst Hu Xiaohui wrote on Weibo.com. "Companies and local governments that have financing needs but cannot get bank loans can fulfill those needs through shadow banking."

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