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It is a sign of the increasing concern of the Chinese authorities that the implosion of their property development sector could ignite a wider financial crisis that they have sent their National Audit Office in to inspect the books of the country’s biggest trust firms.
The review of the trusts, reported by Bloomberg, is said to be focused on loans by the trusts – part of China’s vast shadow banking sector – to property developers, and their plans to deal with those exposures. The audit is also aimed at understanding the risks the trusts might pose to financial stability.
Beijing is desperate to stabilise the property sector with Xi Jinping looking to seal an unprecedented third term later this year.Credit:AP
According to Bloomberg, trust entities have defaulted on about 58 billion yuan ($12.3 billion) of investment products linked to property developers, while developers have more than $100 billion of trust payments due over the next 13 months.
The review of the trusts, which channel the funds of wealthy individuals and institutions into riskier investments than banks and other regulated institutions offer, is telling because, since 2016, the authorities have been cracking down on the shadow banking sector.
The shadow, or unregulated part of China’s financial system has shrunk since 2017 by more than $6 trillion to about 40 per cent of GDP, having been as large as 60 per cent of GDP in 2017.
The sector includes trusts, managed funds, entrusted lending (where a bank acts as trustee but doesn’t expose itself to credit risks) and peer-to-peer lending.
Within the sector, trust lending fell about 44 per cent between 2017 and the September quarter of last year, to about $9.4 trillion, according to Fitch Ratings. Trusts’ lending to property developers has fallen by about a third since 2019, it says, reducing it to about 12 per cent of the sector’s total assets under management.
The authorities, as part of the crackdown, have also sought to distance the shadow banking activities from their regulated banking system to avoid contagion within the core of their financial system.
The review of the trusts and their exposure to property developers, however, suggests that they aren’t entirely confident that the crackdown has reduced the risks the shadow banks pose to financial stability to non-threatening proportions.
They shouldn’t be complacent. The scale of the issues within China’s property sector, the size of the sector within China’s economy and the degree of leverage associated with property in China does make property and property finance a threat to stability.
While the size of the threat posed by shadow banking might have been reduced since 2017, the implosion within the property development sector, the scale of the industry (property accounts for about a third of China’s GDP), shadow banking exposures to property, and the extent of leverage in the property and non-banking sectors mean it remains very material.
Property developers have defaulted on more than $US20 billion ($28.75 billion) of largely offshore bonds this year and the sector shows no signs of stabilising. Indeed, the distress has spread to some of the smaller regional banks, causing them to freeze depositors’ funds and sparking protests.
The pre-sales model used by the development sector has also ignited protests and refusals to service bank loans by mortgagors in more than 320 cities who are facing interest and principal payments on borrowings for uncompleted apartments.
At the epicentre of those protests is the world’s most indebted developer, China Evergrande, with its more than $US300 billion ($431 billion) of liabilities providing some context for the scale of the property crisis.
The concern of the authorities is that, even though they have shrunk the shadow banking sector, it remains sizeable and opaque and its relationships with the rest of the financial system, and banks in particular, are often disguised by complex and less than transparent structures.
China’s big banks are well-capitalised and heavily regulated but, as a spate of scandals and outright fraud has shown, its small and medium-sized banks in the regions have sometimes taken on riskier exposures than would be considered prudent, using off-balance sheet structures to obscure what they have been doing.
In some respects, that’s a natural consequence of the tightening of bank capital and credit standards after the global financial crisis in 2008 even as the authorities were encouraging an apartment-building binge to stimulate economic activity and provide housing to accommodate the large-scale migration of rural Chinese to the major economic centres.
It pushed lending out of the mainstream banking sector and into the shadows and, despite the efforts to reign in and regulate non-bank activity in recent years, it appears the authorities are now concerned – in the midst of the property crisis – that they didn’t clamp down on non-bank activity hard enough.
The scale of the issues within China’s property sector, the size of the sector within China’s economy and the degree of leverage associated with property in China does make property and property finance a threat to stability.
The National Audit Office review of the trusts is looking not just at the extent of the losses and prospective losses the trusts and their investors are facing but for the nature of those continuing linkages between the trusts and the wider financial system.
There are 68 trusts in China with about $4.3 trillion of assets – property loans, shares, bonds and commodities – under management, with property accounting for at least $500 billion of the total.
Their funding tends to be short term, and therefore the potential for liquidity crunches and “runs” — a stampede by investors to get their money out in moments of crisis – and the kind of spreading contagion that the mortgagors’ and depositors’ protests have displayed is latent.
China’s economic model, with its heavy emphasis on centrally driven growth targets, has been funded by increasing levels of debt at every level of the economy and has resulted in households that are leveraged and whose wealth is overexposed to a property market that is imploding.
That risks, not just financial stresses within the economy, but the kind of social unrest that, in the lead-up to the extension of his period as party leader to an unprecedented third term, Xi Jinping wouldn’t want to see develop.
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