[fm]: China's Tricky Problem With eZubao, Shadow Banking And Financial Repression

China has something of a difficult problem to solve in its financial sector: how to balance the growth of banking services outside the state owned and dominated banks and yet also how to make sure that the shadow banking system doesn’t run away with itself and lead to some ghastly crash in the near to medium future. And that’s without the problems of just out and out Ponzi schemes like eZubao. The problem being that the country and economy simply has to move its banking system away from the hugely wasteful and largely state directed system that has prevailed up until now and over to something much more market focused. But how are they to do that without all the cowboys charging in and making hay in a largely unregulated sector? Not just that, how do they stop even honest would be bankers from succumbing to irrational exuberance as our own banks did in 2004- 2008? Yes, I know, people shout that the US and European banks were all acting illegally and so on but really, they weren’t. There was illegality in there, of course there was, there’s illegality in every field of human endeavour. But our problems came from people being wrong, not their being criminal. And that is the problem that China faces.
Yes, sure, there’re the out and out frauds in China:

Panicked customers started to protest and Chinese police investigated the matter. This week, news surfaced that the business was nothing but a ponzi scheme. Chinese authorities broadcasted interviews with detained founder and CEO of eZubao’s confessing about it. However, some feel that the confession perhaps may be done under duress.
The New China News Agency which is run by the state said the company cheated 900,000 clients of a total of equivalent to $7.6 billion. It is probably the biggest financial fraud ever in the history of China.

Just so you know, a Ponzi scheme (named after Charles Ponzi, who originally started with an entirely legal arbitrage scheme on the price difference between international postal coupons and then quickly became over whelmed) is one that says that it is lending out money, investing it, in terribly profitable things and thus sucks in more investors. But the rewards to those early investors are in fact paid out of the new investor money flowing in, there are no investments at all. Bernie Madoff was doing the same thing.
This is a more general problem across the Chinese economy:

The case has underscored the risks created by China’s fast-growing $2.6 trillion wealth management product industry. Many products are sold through loosely regulated channels, including online financial investment platforms and privately run exchanges.
More than 400 billion yuan had been raised by more than 3,600 P2P platforms by the end of November, according to the China Banking Regulatory Commission. More than 1,000 of those firms were problematic, it said.

But here’s the larger problem that China needs to balance against this:

In the last decade, China has seen an explosion of shadow banking, with financial firms like eZubao performing bank-like functions but operating with much less oversight. On the upside, that’s given millions of lower-income individuals and small businesses unprecedented access to credit as well as new ways to invest their savings, no matter how modest their nest eggs may be.
But analysts have been warning for years that the lack of regulation and transparency in the sector could be a ticking time bomb.
Just how severe the problem might be, though, is a matter of contention, since experts can’t even agree on how big China’s shadow banking sector is. A report last year by the Brookings Institution, a Washington-based think tank, said estimates range from $769 billion to $7 trillion.

Take a step back: the banking system in China is largely state owned. Who gets a loan, to invest in what, is largely a political decision. Rather than one based on who is likely to pay it back. This might have had its value at some point but this structure has also led to something called “financial repression”. That is, if political decisions decide who gets the loans, and those political decisions almost always favour the state owned companies (private sector businesses almost never get loans from the state owned banks) then there’s a definite temptation for those same politicians to limit the interest that is paid to depositors. And that’s what has happened: interest rates have been below inflation for a long time now.

By: Tim Worstall. 


 
Review: Emerging Market Formulations & Research Unit, Flagship Records. 
For The #FacebookTeam