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The 'shadow' banks that are failing in China and how can they affect Europe?

2024-02-27 12:12:26Kosova&Bota SHKRUAR NGA REDAKSIA VOX

The 'shadow' banks that are failing in China and how can they affect

Chinese trusts and wealth management companies have been struggling under the weight of tightening regulations and China's ongoing property crisis, two phenomena that have hit the country's "shadow banking" industry particularly hard and could have damaging effects on Europe. Shadow banks, such as Sichuan Trust and Zhongzhi, are non-bank financial institutions, such as credit guarantee companies, hedge funds and asset management companies, that provide some of the core services of banks despite not being traditional lenders.

It is an important sector: according to the International Monetary Fund (IMF), at the end of 2015, the shadow banking industry in all G20 economies amounted to about 92 trillion dollars (84.9 trillion euros). However, despite offering similar services as banks, shadow banking institutions are not regulated in the same way as most traditional commercial banks, thus existing in the "shadows". Rules governing regular banks from which their shadow counterparts are exempt include things like meeting certain capital reserve requirements, transparency requirements and performing full background and credit checks in certain cases.

The shadow banking industry can be key to supporting a country's economy, as it often fills a gap left by traditional commercial banks: for example, traditional banks usually shy away from issuing risky, high-interest short-term loans based on future expectations of a paycheck applicant, while shadow banks may be quick to catch on. In China, the shadow banking industry accounts for about 40% to 60% of the country's gross domestic product (GDP), although estimates vary widely.

Experts believe that China's major property crisis may be the real reason for the struggle of China's shadow banking industry in general. This is because most of the funds that shadow banks earn from selling investment products are then funneled into the country's vast property sector. However, in recent years, this sector has been on the verge of collapse.

One of the main causes of the property sector crisis was when one of the largest Chinese property developers Evergrande defaulted on its bonds in December 2021, causing a chain reaction among other large real estate developers such as Country Garden. Tougher regulations, such as a cap on property builders' debt levels, have also added to the crisis.

The European Union is highly dependent on China as an import and export partner. In 2022, the EU's top imports from China included telecommunications equipment, automatic data processing machines and electrical machinery, according to Eurostat, the bloc's statistical office. On the other hand, some of the main goods exported from the EU to China included motor vehicles and electronic pipes and valves.

The shake-up of the shadow banking industry could go far beyond the financial sector, potentially also affecting European foreign direct investment (FDI) in the country. Currently, the food processing, automotive, pharmaceutical and biotechnology, consumer product and chemical manufacturing sectors are some that see the most FDI in China.

Companies such as Volkswagen, Daimler, BASF and BMW have invested heavily in China. However, the collapse of some Chinese trusts could also mean less demand for European products, particularly in the consumer goods and automotive sectors. In addition, if shadow banks start to reinvest in the property sector, this could also lead to fewer incentives for European companies such as free land and facilities such as massive industrial parks.

As such, China may no longer remain such an attractive investment option for European companies, which may have to find other cheap Southeast Asian manufacturing options. Tighter regulations affecting shadow banks could also deter more European investment in China, especially as the EU and China are currently working on methods to increase self-reliance. One of them involves trying to produce high-demand goods like electric vehicles entirely domestically, without relying on foreign supply chains.


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