With $660bn of Chinese trust loans falling due this year, the increasingly troubled sector looks set to pose one of the stiffest tests yet for policy makers in the world’s second-biggest economy.
Trust loans, which are typically two years in duration, make up the largest slice of China’s vast shadow banking sector. Together with shorter-term wealth management products, shadow financing rose to account for over a third of new credit in the country in 2013.
Such loans have become vital to the Chinese economy. They are often used to fund infrastructure projects or property development, and by banks to eliminate assets from their balance sheets so that they can extend credit elsewhere. Trusts currently have around Rmb7tn ($1.2tn) in assets, up from just Rmb2tn three years ago.
Concerns about the sector have been running high since last week, when ICBC became the first Chinese bank to indicate that it would not bail out a trust product sold through its branch network.
Although local media now say that the Shanxi provincial government is working on a rescue package for the fund, economists say it is simply a matter of time before the sector sees its first defaults on products many had assumed to be safe.
Should investors then begin to shy away from shadow banking products – something rising domestic bond yields suggest is already under way – analysts warn that infrastructure projects across the country could grind to a halt as local governments, who rely on trust loans, are starved of new cash.
“Infrastructure investment is already slowing, that’s probably a reflection of the financing channels getting tighter,” said Zhang Zhiwei, economist at Nomura. “The central government can still handle this issue, or put it off until next year. But in the short term it will lead to a growth slowdown.”
Many investors have bought into trusts and similar investments from state-owned banks believing them to be underwritten by the government. ICBC’s move raises the chances that investors will be left with worthless assets, something that could have a ripple effect across the financial system.
“People buy [local government] debt because they largely count on an implicit government guarantee. If that guarantee is removed, it will be a lot easier for the market to get spooked,” said David Cui, China strategist at Bank of America Merrill Lynch. “Once investors turn more cautious, banks will have to liquidate positions in order to pay them back. Then you get a negative feedback loop.”
The $500m loan at the heart of the ICBC saga is just the tip of the iceberg. According to estimates from Bank of America Merrill Lynch, about Rmb4tn of trust loans mature in the next 12 months.
Even if investors are bailed out this time, the change in risk perception may be hard to reverse, and would come at a critical time for the economy. The latest growth figures, released on Monday, showed that China is continuing to slow, and that the country is still reliant on fixed asset investment to keep things humming.
Chinese authorities now face a tough balancing act in order to work out the country’s growing debt pile, and introduce the concept of default risk into the shadow banking sector, without provoking a sharp shock to the system. Some say a default is not only unavoidable, but actually desirable.
“The default of trust products could trigger some short-term negative impact to China’s financial sector and the reputation of financial institutions,” wrote Barclays analyst May Yan in a research report. “However, we believe it would be positive for the healthy development of the financial system in the long run.”
Liu Li-Gang, China economist at ANZ, said authorities will look to carry out a “controlled explosion” of the local government debt problem.
“If you squeeze too hard and too suddenly, definitely it will create a systemic impact on an overleveraged financial system,” he said.
He believes local governments will turn to alternative options – such as municipal bonds and private equity money – to refinance projects currently reliant on trust loans.
美银美林(Bank of America Merrill Lynch)中国策略师崔伟(David Cui)表示：“人们会购买（地方政府）债务是因为，他们在很大程度上指望政府的隐性担保。如果这种担保不复存在，市场恐慌的发生要容易得多。一旦投资者变得更加谨慎，银行将被迫清算相关资产，以向投资者兑付。那时就会出现恶性循环。”