Regulated system of shadow banking in China can benefit private firms
- Such companies are considered high-risk, relative to state-owned enterprises, by banks and there is room for monitored alternative platforms to provide badly needed funds
China’s private sector needs a little love, and Beijing is ready to give it. As mainland firms bear the brunt of the fallout from America’s trade war, regulators have instructed state-owned lenders to turn on the tap. The policy makes sense, if only banks knew how to implement it, that is assuming they even wanted to. The head of the China Banking and Insurance Regulatory Commission, Guo Shuqing, said at least a third of new loans should go to private firms, rising to 50 per cent in three years.
Last year, the private sector contributed more than 60 per cent of growth in gross domestic product and created eight out of every 10 new jobs. Yet big lenders continue to favour state-run enterprises.
The long-standing debate has reached a critical point, with President Xi Jinping praising the importance of the sector to the overall economy. His statement that private firms are part of the economy is also an answer to American criticism that China refuses to speed up the opening and liberalising of its domestic market.
For lenders, private firms are considered high-risk, relative to state-owned enterprises. Most also lack comparable political clout and connections. Meanwhile, many big banks claim it is difficult to meet lending quotas when there is no hard-and-fast rule to determine which firms qualify. Some ostensibly private firms involve substantial state ownership, from municipal and provincial up to the national levels. Also, what’s to stop a state-run company from setting up private entities with the tacit understanding of their state lenders? But the banks also have a valid argument. Loose lending will create massive bad loans down the road, which runs contrary to Beijing’s fight to deleverage the financial system in the past few years.
These are difficult but not insolvable problems. To start with, firms tied to different levels of government are not necessarily less risky. When they become insolvent, lenders are often instructed to write off their loans even as they continue to operate like “zombies” to retain employment. To lend responsibly, banks need to strengthen credit-risk management and carry out due diligence on commercial principles rather than political consideration, regardless of whether an entity is private, state-owned or mixed. This, of course, means banking reform rather than administrative measures.
In recent years, the dearth of state-lending support and the rise of fintech have led to an explosion of lending in the shadow banking sector. These include high-risk peer-to-peer, or P2P, lending platforms that are not subject to interest rates control. The fraudsters and also-rans need to be weeded out, but those that are well-funded and managed should be encouraged under a proper regulatory framework. They can contribute by picking up the slack from the more tightly controlled state lenders.