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China’s Credit Binge Has Driven Its Banks to Hide $2 Trillion in Loans

December 8, 2016, 9:17 AM UTC
General Views of Caofeidian Industrial Zone
A poster featuring Xi Jinping, China's president, hangs on a wall as residential and commercial buildings stand in the background at the Caofeidian industrial zone near Tangshan, Hebei province, China, on Wednesday, Aug. 10, 2016. The best-performing bank in China is in a struggling city in the northeast where weeds sprout alongside the concrete skeletons of high rises in an industrial zone that mostly looks like a ghost town. Photographer: Qilai Shen/Bloomberg via Getty Images
Photograph by Qilai Shen—Bloomberg via Getty Images

China’s banks are masking loans as investments through an accounting trick to the tune of $2 trillion, or about 20% of their existing loan portfolio, according to a Wall Street Journal tally.

With China’s latest economic growth recently being driven by unprecedented levels of debt, that debt is gaining increased attention. Two years ago the focus turned to shadow banking, the non-bank financing that included runaway wealth management products and trust loans. Now it is shadow banking of another kind.

Off-balance sheet vehicles and a hodge-podge of bank and non-bank lending are behind the current rise. It is this “plumbing” that makes China risky for a crisis if liquidity dries up following a property slowdown or other triggering event, according to Emerging Advisors Group.

The two trillion dollars worth in lending, miscounted as investments, is a symptom of the plumbing problem. The investment categorization means the banks aren’t holding capital against potential losses. Many of the loans are made to property developers. If China’s rising property market stalls or reverses, those loans could quickly overwhelm their lenders. It would then be up to the government to decide whether to bail them out. A similar contagion afflicted Western banks during the 2008-2009 financial crisis.


Chinese officials are aware of the problem. “The rapid growth in banks’ off-balance-sheet and investment activities, in essence, means hidden credit risks and could threaten financial safety,” the Journal quoted the country’s chief banking regulator, Shang Fulin, saying in September.

But lending by any means necessary is a directive coming from the highest levels in China. President Xi Jinping said last year the country must at least post 6.5% annual economic growth through 2020. And China’s state-owned banks have received government directives over the past year to support economic growth by issuing credit.

That means state bankers, whose standing in the Communist Party is equal to that of city or provincial leaders, are rewarded for lending to struggling business, despite the risks. In the 12 months through June, China’s domestic debt ratio rose by an astonishing 28% of GDP.

That’s faster than during the 2008-2009 stimulus when it pumped $600 billion into the system. And that means more examples of the credit excesses in China will be coming in the near future.

Until then, China’s official total debt level of 250% of GDP won’t ever tell the full story.