Leveraging of Chinese economy continues to rise through shadow banking system

The term shadow banking refers to practices of regulated and unregulated financial entities that use derivatives to create credit that escapes financial regulation. Photo / Getty

The overall leverage in China's economy continues to rise, as credit growth -- measured by total social financing (TSF) -- outpaces nominal GDP, Moody's says.

The ratings agency currently has the Chinese economy at Aa3 on negative watch.

"The growth in overall leverage may be understated, because some of the fastest growing components of shadow banking are not included in TSF," says Michael Taylor, a Moody's Managing Director and Chief Credit Officer for Asia Pacific.

"We estimate the potential understatement to be significant, amounting to at least RMB16 trillion (NZ$3.4 trillion) or 23 per cent of GDP at end-2015, equivalent to around one-third of shadow banking," he adds.

The term shadow banking refers to practices of regulated and unregulated financial entities that don't take deposits in the traditional sense, including hedge funds and mutual funds, but which use financial derivatives to facilitate the creation of 'shadow credit' outside of mainstream system. While they borrow and lend money they do so in a way that does not subject them to banking regulations, acting as an intermediary between big borrowers and big lenders.

We estimate the potential understatement to be significant, amounting to at least RMB16 trillion ($3.4 trillion) or 23 per cent of GDP at end-2015, equivalent to around one-third of shadow banking

Michael Taylor, Moody's Managing Director

Shadow banking activity in China has expanded further in 2016, said the Moody's analysis contained in its latest Quarterly China Shadow Banking Monitor.

"The rise in overall leverage and further expansion of shadow banking activity are pushing up financial risks," adds Stephen Schwartz, a Moody's Senior Vice President.

He notes in particular that, "continued growth of banks' investment receivables is increasing the system's interconnectedness, as well as exposing mid-sized and smaller regional banks to liquidity and credit risks."

The investment receivables (debts, unsettled transactions) of a sample of 26 listed banks have more than quadrupled since 2012, accounting for more than 8 per cent of their total assets at end-2015.

Finally, it notes that e-finance is also expanding rapidly in China, benefitting from opportunities afforded by an underdeveloped consumer banking system.

The overall share of e-transactions of non-banks remains small in comparison to the volume of bank e-platforms, but is increasing steadily.