Opinion | Near-default must spur action on China's shadow banking sector
Hu Shuli says regulators need to spell out ways to moderate the dangers as bailout does nothing to address the problem of moral hazard
On the eve of the Lunar New Year, news that a default on a 3 billion yuan (HK$3.8 billion) trust product had been averted brought relief to some in China. This was the trust industry's most serious crisis to date. The danger may have passed for now, but the last-minute bailout has shone a light on the growing risks lurking in the country's shadow banking sector.
In 2011, China Credit Trust, one of China's largest "shadow banks", issued an investment product seeking 3.03 billion yuan. Credit Equals Gold No 1 offered investors an annual 10 per cent return for three years - no doubt with a hefty cut going to the issuing company - to be paid back in full by January 31.
Whether these terms could be met depended on coal prices remaining high. But not only have prices fallen in a cyclical downturn in recent months, the fund's borrower, Shanxi Zhenfu Energy Group, collapsed under a mountain of debt in 2012 after its major shareholder, Wang Pingyan, was arrested for illegal deposit-taking.
Investors had one other reason to think their investment was sound. The Zhenfu group had let it be known it was close to buying a coal mine in Luliang that was known to produce high-quality coke. But until the end of last year, such a deal was wishful thinking on Zhenfu's part, as the local government had not approved it.
The fallout from Zhenfu's collapse should have been left to take its course. In a free market, the issuer, distributor and investors should all bear the costs of an investment blunder. But instead, unnamed third parties came to the rescue to allow investors to recoup their full principal and most of their interest earned.
China Credit and the distributor, the Industrial and Commercial Bank of China, probably found a state-owned asset management company to restructure the fund. If so, the rescue would be similar - in nature if not in scale - to that of the dozen or so failed trust products since last year, all of which were based on a long-standing belief that the government would not allow any default for fear of knock-on effects on the whole banking system.
In recent years, financial regulators have repeatedly stressed that, in a free market, both buyers and sellers must bear full responsibility for their investment risks. Hence, when news emerged that the China Credit product was facing default, some industry players speculated that it might be the first allowed to go sour. But at the moment of truth, the authorities chickened out and chose to take the "safer" route of a rescue.