Crisis Sparks Calls for Policy Response to Shadow Banking, Reports Reuters

By Summer Zhen, Laura Matthews

HONG KONG/NEW YORK – Growing concerns in China regarding missed payments on certain shadow banking trust products and declining consumer sentiment are prompting expectations of a swift policy response to revitalize the country’s cash-strapped property sector.

The fear surrounding China’s $3 trillion shadow banking sector—roughly equivalent to Britain’s economy—has intensified over the past year, as the sector has faced a series of crises. Recently, Zhongrong International Trust Co., known for its significant real estate exposure, missed repayments on some of its investment products, raising fears of contagion.

Trust firms operate outside many regulations applicable to commercial banks, primarily directing the proceeds from wealth products sold by banks to real estate developers and other sectors, including individual retail investors.

Analysts have indicated that if the market deteriorates significantly, regulators may swiftly intervene, similar to measures previously employed by China to mitigate financial volatility, such as liquidity injections.

"The risk of systemic shock to the Chinese financial system is not significant, but the downward pressure on the economy is likely to increase," said Yan Wang, chief emerging markets and China strategist at Alpine Macro. "These issues are interconnected, and contagion is already occurring, making it crucial for the government to respond promptly and decisively."

In a move reflecting this urgency, Beijing recently cut key policy rates following a range of data suggesting escalating pressures on the economy, particularly from the property sector. Over the weekend, two companies announced they had not received payments on maturing investment products linked to Zhongrong International Trust.

Nomura warned that a wave of defaults on trust products could lead to "substantial ripple effects" on China’s broader economy, with losses for individual investors—attracted by higher returns—potentially severely impacting consumption.

Arthur Kroeber, partner and head of research at Gavekal, noted, “The problems are likely to extend beyond this individual trust firm and become more evident across the entire trust industry. However, they are manageable by the government without triggering a catastrophic collapse, even though it is a gradual and slow-burning issue.”

While China’s property dilemmas have severely impacted the economy in recent years, Beijing has managed to contain the repercussions on the financial sector thus far. Analysts at Columbia Threadneedle Investments posited that these developments might present a buying opportunity in government bonds.

The trust sector has historically been a primary fundraising avenue for property developers eager for rapid growth. However, following a downturn beginning in 2021, some developers have gone bankrupt, while others have pulled back their investments in property firms.

Since 2017, Beijing has increased efforts to shrink the shadow banking sector, citing concerns over financial stability. By the end of 2022, the assets held by trust firms totaled 21 trillion yuan, representing a 20% decline from the end of 2017. The outstanding value of trust products invested in the property sector was 1.2 trillion yuan at the same point, down approximately 30% year-on-year, although exposure levels vary among different trust firms.

“The real contagion may already be manifesting in the form of weakened consumer and business confidence, which continues to drag down growth,” stated Kamil Dimmich, partner and portfolio manager at North of South Capital LLP. “While the government is aware of this dynamic, its responses have been rather cautious.”

Given that trust product clients are typically affluent individuals or businesses, analysts at Barclays suggest that authorities might tolerate market forces running their course for a while.

Phillip Wool, co-portfolio manager at Rayliant Quantamental China Equity ETF, remarked that the escalation of defaults among trust firms could further erode confidence, making potential homebuyers hesitant to commit large down payments. “If Beijing does choose to intervene, it will be at a critical juncture where declining confidence becomes increasingly difficult to reverse,” he added.