Illuminating confessions from a shadow banker
Finance veteran lifts the lid on a murky world where conflicts of interest and corruption collide, producing a credit bubble ripe for a global crisis
Everyone knows China's shadow banking market is big. According to the ratings agency Moody's, the shadow market was worth 20.5 trillion yuan (HK$25.9 trillion) at the end of last year, or 39 per cent of China's gross domestic product.
And everyone accepts it is growing fast. Even a narrowly conservative estimate indicates the sector grew by 1.9 trillion yuan over the first four months of this year to reach at least 22.4 trillion yuan at the end of April.
But beyond that the consensus breaks down. No one seems able to agree whether the rapid growth of shadow financing threatens the stability of China's formal banking system, nor whether a crisis in the shadow market could endanger the future development of the Chinese economy itself.
This disagreement isn't too surprising. By definition, shadow banking is a murky business, opaque to outsiders and often poorly understood by its own participants.
One person who is uniquely well placed to understand what is going on, however, is Joe Zhang. Zhang is probably best known in Hong Kong as the UBS analyst who back in 2001 triggered the collapse of agricultural giant Euro-Asia, whose chairman Yang Bin later eventually ended up in prison.
But as a young central bank official in the late 1980s, part of Zhang's job was to monitor fluctuations in the mainland's black market interest rates.
Then, having risen to become deputy head of China investment banking at UBS, in 2011 he quit his job to become chairman of Guangzhou-based Wansui Micro Credit, a shadow market lender.
Now, two years on, he has written a book about his time at Wansui, entitled Inside China's Shadow Banking. His experiences are both illuminating and depressing.
Wansui was a small business specialist, lending short-term funds at interest rates of between 22 and 24 per cent to private companies with no access to formal bank credit.
The firm's average loan size was just 133,000 yuan, but Zhang soon discovered one 20 million yuan loan to a fish farm and a 5 million yuan loan to a furniture store. Within a year, both defaulted.
Then he found his managers, undeterred by the defaults, had made another 20 million yuan loan at cut-price rates and over an unusually long maturity to a small local air-conditioner company that boasted it was in line for a stock exchange listing.
The reason, he discovered, was that the managers had accepted stock options from the company in the hope that a loan from Wansui would translate into a handsome profit for themselves personally when the borrower finally listed.
Other proposed deals turned out to be even more murky. For example, there was the private equity investor who had used his connections with a big state bank to obtain cheap funds, which he proposed investing in local government infrastructure projects. Only his "equity" stakes would come complete with a buy-back clause, which effectively meant they were loans, disguised to allow the bank's executives to exceed both their loan quotas and their lending rate cap to pocket a handsome 25 per cent return.
There are plenty more examples. Zhang depicts China's shadow banking sector as a market in which greed rules, abuses abound, and conflicts of interest run riot amid rampant official corruption and bitter regulatory infighting.
It is not an encouraging picture.
"Negative real interest rates and runaway credit growth have reinforced each other," he concludes, "creating the biggest credit bubble on the planet."
At best, Zhang says, Beijing will opt to deflate the bubble, which will mean mass bankruptcies, rising unemployment and possibly a recession.
At worst, it will do nothing. In that case, he warns, "this bubble is likely to become the origin of the next global crisis".