China’s attempts to rein in its enormous shadow banking sector seem to be taking effect—although, as is often the case with opaque layers of the economy, the results have to be deduced from larger trends.
“Aggregate financing,” a broad measure of credit that lumps together shadow finance as well as traditional bank loans, plummeted to 1.07 trillion yuan ($172 billion) in February from a record 2.54 trillion yuan in January. That includes money from unconventional sources, such as “wealth management products” that collect cash from sometimes unsuspecting depositors. In recent years, shadow finance has grown larger than formal bank lending.
Analysts polled by Bloomberg had expected aggregate financing to be much higher, with estimates ranging from 1.4 to 1.8 trillion yuan.
The nation’s economy feeds on huge state investment in new projects such as roads, railways and ports. The government has targeted $160 billion of new infrastructure spending this year (paywall). But Beijing usually does not pay for such projects itself. Instead, financial responsibility often falls to indebted municipal authorities. The local governments are barred from taking bank loans or issuing bonds themselves, so they ask banks to provide them with covert, off balance sheet cash.
When Beijing cracks down on unconventional lending by forcing banks to disclose these loans, municipal governments’ ability to pay for new roads, railways and ports takes a hit. Beijing could compensate by allowing conventional bank credit to increase, but that would threaten China’s financial stability over the longer term. China’s credit- to-GDP reached 190% last year (paywall), and the debt-fueled spending is increasingly inefficient: China now needs three yuan of credit to generate one yuan of growth. That’s a sobering ratio whether the lending takes place out in the open, or in the shadows.