Opinion In the dark

At 7.7 per cent in 2013, its growth rate is already at its lowest since the late 1990s. It is clear that China’s grand reorientation — from an export-driven economy to a consumption-based one — is not going to be smooth. Questions are rightly being raised about the impact of this realignment on the global economic recovery. But the threats posed by China’s shadow banking sector are far more ominous for the world economy.

Shadow banking is an umbrella term that encompasses a variety of non-traditional lending activities designed to function outside normal regulatory control. According to JPMorgan, the Chinese shadow banking sector doubled between 2010 and 2012 to $6 trillion or about 70 per cent of the GDP.

Shadow banking fulfils the demand for credit from ventures, including highly risky ones, that may not get bank finance — in part due to excessive regulation and political interference — and is partially responsible for the surge of debt in the economy. But the fact that the sector is harbouring toxic assets was most recently demonstrated last Friday, when a solar energy equipment manufacturer defaulted — a first for China’s corporate bond history.

In January, China Credit Company, a shadow banking firm that had loaned $500 million — marketed by the Industrial and Commercial Bank of China — to an unlisted coal company, was about to default. While a bailout package was eventually arranged in this instance, incidents such as these can touch off an unravelling of the sector.

It is doubtful whether policymakers, who may not even know the extent of the risk, can curtail shadow banking without cutting off the supply of finance to a large subsection of the economy. While the Chinese financial system doesn’t have the kind of interlinkages that Western systems responsible for the 2008 meltdown do, the effects of an implosion would be catastrophic on global recovery and investor sentiment.