You think China's ~A$48 trillion in shadow loans will end well?


In 2 weeks from now China will begin its 19th Annual Congress, so I thought I would revisit one of the more worrying aspects of its economy.

Shadow banking activities include activities outside the regular banking system. Depending on who you speak to, this includes activities carried out by unregulated entities (difficult to quantify) as well as unregulated and/or off-balance sheet activities undertaken by regulated entities (something that banking institutions register).

Due to associated definitional challenges, secrecy and other factors,  estimating their volume is difficult.

This goes in the difficult basket along with trying to quantify how many quadrillions of derivatives exist and/or seeking to have estimated the then volume of credit default swaps on sub-prime mortgages, prior to the GFC.

That said, last night I read an article from the UK Telegraph suggesting that volumes might range somewhere between 8% to 80% of China GDP.

That sounded low to me given the size of China's GDP and higher numbers posed more recently. I was also interested in the relationship between on-balance sheet assets and off-balance sheet loans.

Reading through China's 'Financial Stability Report, 2017' published by the Financial Stability Analysis Group a few months ago (luckily I kept a copy), we find:

"The off-balance sheet business continued expansion, while the embedded risks remained."

Sound ominous? The Analysis Group went on to estimate/quantify entrusted loans and entrusted investments at the end of 2016, including guarantee business, commitment operations and financial asset services of banking institutions.

It concluded that these accounted for 109.16% of total on-balance sheet assets, up by 12.04 percentage points from the previous year

In terms of the gravity of this number, we are talking about somewhere in the vicinity of A$48 trillion (RMB 253.52 trillion yuan) or more of shadow debt on top of ~A$36 trillion of non-shadow debt, on top of ~A$44 trillion of, let me do the math on that.

Let's not even think about what ratio that represents of China GDP, which the World Bank estimated to be ~US$11.2 trillion (A$14.4 trillion) at the end of 2016.

The Analysis Group then concluded:

"Weakness remained in the management of off-balance sheet business, and contagion between on- and off-balance sheet activities might exaggerate."

Maybe as a Communist country the visible hand will be able to intervene if and when there is a crisis, but if this was anywhere else - major reset.