The COVID-19 outbreak has cast a gloomy shadow over not only the formal financial industry of China, but also its shadow banking sector as well. Shadow banking basically refers to the unorganized credit-creating financial intermediaries that are not subject to regulatory oversight.
Shadow banking problems
In April, credit rating agency Fitch predicted that the Chinese shadow banking system will come under pressure this year as the pandemic squeezes the ability of private companies to generate cash flow. “We expect that shadow-banking assets as a share of GDP will continue to fall in 2020, reaching 41 percent of GDP by end-2020 from an estimated 43 percent at end-2019.
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“In part, this will reflect risk aversion among the sector’s lenders, who will be reluctant to increase their exposure at a time when economic conditions are particularly tough for borrowers,” the agency said in a statement.
Xu Zijun, a Beijing-based senior analyst at Reality Finance Research, believes that we will see record defaults from the 5.4 trillion yuan (approx. US$800 billion) in trust offerings that are due this year. These are high-yield financial products that are often sold to wealthy people, banks, and institutional investors.
Zijun calculates about 300 such products to default by the end of this year, which will be more than double the last year’s figure of 118 defaults. According to the China Trust Association, around 1,500 trust products with a combined value of 577 billion yuan (approx. US$85 billion) were classified as risky at the end of 2019.
Fitch had expected that Chinese regulators might ease their grip over the shadow banking sector given that the pandemic has created a liquidity crisis. As such, whatever credit can flow through the market is usually welcomed. However, the reverse seems to be happening right now. China’s Supreme Court has set a cap on private lending interest rates to around 15.4 percent, lowering it from the previous 24 percent.
This would spell big trouble for small businesses and individuals who rely on the informal credit sector to secure funds. Lenders from the shadow banking sector are likely to cut back on loans due to the lowered interest rates. Fitch believes that the new ruling will negatively impact sectors like micro-lending, consumer finance, and used-car auto leases.
Formal banking sector
As far as the formal banking sector is concerned, things aren’t looking too good either. Chinese banks have declared a huge decline in net profits for the first time in several decades. These institutions have raised their provisions for bad loans by 656 billion yuan (approx. US$95.8 billion), underlining how serious the financial situation of the country is.
The industry regulator has already declared that banks will be writing off 3.4 trillion yuan (US$500 billion) in bad loans this year, which is around 50 percent more than what was disposed of last year. Plus, almost 4 percent of the bank’s troubled debts, equivalent to 7 trillion yuan (approx. US$1 trillion), have apparently been deferred to next year.
Chinese companies are also defaulting on foreign loans. According to Fitch, nine firms from China have defaulted on their foreign currency bonds in 2020, totaling roughly US$4.5 billion. This has easily surpassed the US$3.3 billion that Chinese companies defaulted in 2019. And the year is not even over yet. By the end of 2020, almost US$54 billion in bond repayments are expected to be due. As such, more defaults are on the cards.