Société Générale: China’s Shadow Banking Needs A Rescue

Société Générale said today that the on-going crisis in the Chinese shadow banking system, as discussed for a number of times here over the past many months, will require a rescue, not surprisingly.

While no one knows the exact size of the shadow banking system, it is likely in the order of tens of trillion. Société Générale’s estimated that the whole shadow banking system is about CNY14-15 trillion in size, of which the underground banking may account for 3-4 trillion of it (which includes stuff like loan sharks, pawnshops and others that we have be talking about here time and again). And these are the things that are currently making people worried…

Source: Société Générale

Curiously though, Wei Yao of Société Générale wrote the following:

The fact that SMEs are willing to borrow money at 20~180% interest rates reflects that they are either desperate for cash or that they are involved in speculation, as no real business can generate that high a return to cover the repayment. Hence, at least some part of the damage caused so far is intended by policymakers.

So policymakers may be quite happy to see these businesses to fail. However, she notes that things may get worse:

The situation may get worse in coming months. Demand for cash will rise significantly as we approach the yearend…

A significant downturn in the property sector would aggravate the liquidity crunch, turn local issues into a systemic one, and impair the fiscal standing of indebted local governments… [but] formal banks should be able to bear a certain amount of correction in the property sector.

Total formal loans to SMEs were reported to be CNY 9.7trn. Besides, there are several hidden linkages between shadow and formal systems. The head of the banking regulator estimated that nearly CNY 3trn of formal commercial loans have trickled down to shadow banking, as large enterprises and SOEs (illegally) either relend bank credit to cash-starved SMEs, or in other cases, act as guarantors of shadow borrowing. Therefore, NPLs of banks are very likely to rise noticeable, if the liquidity crunch of SMEs continues.

But the deus ex machina a.k.a. the Chinese government may come to rescue. In fact, it might have been happening:

We do see the authorities responding with specific easing measures. Banking regulators are reportedly saying that banks should be more tolerant of SME defaults in order to help them through difficult times. Initiatives, such as collective issuance of SME bonds, are also seen as offering increasing scope. Further steps may follow; regional credit quotas and relaxing reserve requirement ratios seem possible avenues. As for more general easing, the probability of RRR cuts in this quarter will rise significantly if the property market takes a sharp turn.

The bottom-line is that things can get worse on this shadow banking system if the cash crunch continues and if property prices fall more sharply. However, they are still not expecting hard landing, believing that the Chinese policymakers have the ability to deal with the situation.

For more news and analysis, visit Also sprach Analyst. Follow us on Twitter and Facebook.

Get our daily email update FOR FREE!

About Zarathustra

Zarathustra: Founder and Managing Editor of Also sprach Analyst. Once an analyst, now an investor and entrepreneur. Based in Hong Kong, but Londoner at heart.