The Potential Crisis, the Increased Shadow Banking in China?

China, as a representative country of emerging market, plays a more significant role in the global financial market. Consequently, Chinese financial market experienced a dramatic change with improving financial liberalization in the past decade. Diversified derivatives and Chinese unique financial character accelerate the developing speed of maturity of the financial market indeed. However, the invisible risk contained in shadow banking threat the processing of Chinese financial market to some extent, the possibility of shadow banking's collapse is increasing resulted by aggressive blast rising scale of shadow banking.

As we discussed in the last post, the property of shadow banking determines the high risk existed in the associated financial chain. Compared with the particular characteristics of USA's shadow banking, the shadow banking system in China has some distinguishable properties, which indicates the background of specified country could influence the shadow banking (story here). So we attend to find out the particular differences by comparing the component contained in shadow banking.

 Firstly, the main content of shadow banking in USA is based on the financial innovation, for instance,asset-backed commercial paper, structured invest vehicles, subprime mortgage and so on. In contrast, the main operation contained in shadow banking of China is off-balance sheet activity of  formal banking and unregulated private finance, which denotes the shadow banking are associated with national economy. Under the specified condition, Chinese economy is experiencing a mode change, it means the growth of economy is hardly predicted and the investors are facing a default risk due to the shadow banking.

Secondly, the participators in shadow banking are quite different. In USA, the main players in the system are non-financial institutions, such as, investment banks, hedge fund, bonds and insurance companies. On the other hand, the main participators in China are commercial banks, private companies and underground loan institutions. This characteristic determines the hardness of regulation on shadow banking in China to some extent. The graph depicts the main components in the shadow banking system of China.

Lastly, in China, the regulation institution still does not have a specified definition of shadow banking, but actually the scale of Chinese shadow banking is increasing dramatically. Deutsche Bank estimates that the scale of Chinese shadow banking was 21 trillion yuan, equivalent to 40% of the GDP (story here). The need of define the detail operation of shadow banking and establish specified regulation is really pressing. If the government could not handle the problem properly, the consequence must be incredible and horrible for the global economy.

As usual,  we share a video taking about the particular condition of shadow banking industry at last, really do hope my blog can offer an interesting concept of shadow banking to some extent. 

The Past Crisis Era, Invisible Risk and Strict Regulation for Shadow Banking?

Based the collapsing of American housing market, the associated derivatives were crashed. These derivatives mostly were defined into the shadow banking system, which drawn attention of the government and normal individuals. Moreover, the invisible risk of shadow banking was faded its cover by public, people attend to assess the magnitude of risky coefficient for different financial product belong to the shadow banking system. The scale of shadow banking was influenced to a large extent consequently.The figure depicts the changing trend in the period from 2002 to 2011, it explicitly denotes there is a huge discrepancy between the increasing speed before 2007 and that of which after 2007.

Particularly, for the USA market, the shadow banking is not the nominally traditional banking,  but it plays the similar role indeed as the traditional banking which typically offer financial bridge combining borrowers with lenders. Before the financial crisis, the shadow banking substitute the traditional banking as the mediation in the subprime loan. Moreover, shadow banking issue diversified derivatives with high leverage, combine different financial products and sale them to whole investors. Consequently, it resulted the cumulative financial risk chain which is volatile and fragile. High leverage, volatility, informational closure and lack of regulation, all these factors cause that shadow banking  breeds potential risk. 

Thus, in the past crisis era, not only the USA government but also other developed countries' government realize that regulation is the core part to secure the shadow banking system. They established diversified policy to define the detail of shadow banking's operation explicitly, which reduce the opportunity of inside operation and monitor the behavior of managers of varied financial institution included in the shadow banking system. For example, Goldman Sachs has been renamed as a bank holding company Goldman Sachs Group Inc, is also due to get a strong government bailout, but was included in the regulatory areas.

The video below is introducing the exigent need for regulating banking and reducing the high potential risk.    

 

As above said,  the high risk in shadow banking drawn attention from government and institutions, avoid the potential financial risk become the mail task for each government focus on establishing a healthy financial market. Shadow banking would not been remove from the market, but it would be under a strong regulation and a highly disclosure environment. 

Thus, in the next post, I would like to introduce a hot topic recently, which is the risk of  dramatically increased shadow banking in China would lead a second financial crisis?