China’s confidence audit shows how worried it is

Examination of trusts and their exposure to property developers, however, suggests that they are not entirely convinced that the crackdown has reduced the risks that shadow banks pose to financial stability to non-threatening proportions.

They shouldn’t be complacent. The scale of the problems within China’s real estate sector, the size of the sector within the Chinese economy, and the degree of indebtedness associated with real estate in China make real estate and real estate finance a threat to stability. .

Although the scale of the threat posed by the shadow banking system may have been reduced since 2017, the implosion of the real estate development sector, the scale of the industry – real estate accounts for about a third of China’s GDP – shadow banking exposures to real estate and the extent of leverage in real estate and the non-banking sector keep it very material.

China Evergrande is at the center of the country’s real estate crisis, with its more than $300 billion in debt providing context for the scale of the problem.Credit:Bloomberg

Property developers have defaulted on more than $20 billion in largely offshore bonds this year and the sector shows no signs of stabilizing. Indeed, the distress has spread to some of the smaller regional banks, forcing them to freeze depositors’ funds and sparking protests.

The pre-sale model used by the development sector has also sparked protests and refusals to repay bank loans by mortgagers in more than 320 cities who face interest and principal payments on loans for apartments. unfinished.

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At the epicenter of these protests is the world’s most indebted developer, China Evergrande, with its more than $300 billion in liabilities ($431 billion) providing context for the scale of the real estate crisis.

The authorities’ concern is that, even if they have reduced the shadow banking sector, it remains large and opaque and its relations with the rest of the financial system, and the banks in particular, are often masked by complex structures and little transparent.

China’s big banks are well capitalized and heavily regulated but, as a series of scandals and outright frauds have shown, its small and medium-sized banks in the regions have sometimes taken riskier risks than would be considered prudent, in using structured off-balance sheet transactions to obscure what they did.

In some ways, this is a natural consequence of the tightening of capital and credit standards for banks after the 2008 global financial crisis, even as authorities encouraged a frenzy of apartment building to stimulate economic activity and provide housing to accommodate the large-scale migration of rural Chinese to major economic centers.

It has pushed lending out of the traditional banking sector and into the shadows and, despite efforts to control and regulate non-banking activity in recent years, it appears authorities now fear – amid the housing crisis – that they did not sufficiently repress non-banking activities.

The scale of the problems within China’s real estate sector, the size of the sector within the Chinese economy, and the degree of indebtedness associated with real estate in China make real estate and real estate finance a threat to stability. .

The National Audit Office’s review of trusts focuses not only on the magnitude of losses and potential losses that trusts and their investors face, but on the nature of these ongoing links between trusts and the wider financial system. .

There are 68 trusts in China with around $4.3 trillion in assets – mortgages, stocks, bonds and commodities – under management, with assets accounting for at least $500 billion of the total.
Their funding tends to be short-term and therefore the risk of cash shortages and “rushes” – a rush by investors to withdraw their money in times of crisis – and the kind of contagion spreading that protests mortgage debtors and depositors have manifested is latent.

China’s economic model, which places a strong emphasis on centrally-oriented growth objectives, has been funded by rising levels of debt at all levels of the economy and has resulted in indebted households whose wealth is overexposed to an imploding real estate market.

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This risks, not only financial strains within the economy, but the kind of social unrest that, with the prospect of extending his period at the helm of the party for an unprecedented third term, Xi Jinping would not want to see. grow.

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