Analysis. The government is trying to manage the crisis. In 2023, Chinese provincial authorities pumped a record $31 billion into regional banks through special bonds.

China’s shadow banking system shows signs of cracking under enormous debts

It’s finally happening: the real estate crisis is having a contagion effect on China’s shadow banking system. The bankruptcy filing by Zhongzhi, accepted by the Beijing court, is a potential great leap in terms of the problems that are slowing the growth of the People’s Republic. Zhongzhi is an enormous financial conglomerate with a sprawling involvement in various asset management activities, one of the traditional pillars of the multifarious galaxy of trust funds peculiar to the economy with Chinese characteristics.

The company, which at the height of its success had come to manage $139 billion in assets, told investors it had accumulated liabilities of up to $64 billion – more than all of its current assets, estimated at about $38 billion. As a result, it is unable to repay its debts. This is a blow to the shadow banking system, consisting of funds, lenders and intermediaries that move outside the traditional banking circuit.

The fate of this informal lending sector, which exploded after the 2008 financial crisis, is inextricably tied with real estate. Private builders have been growing at a record pace for decades, thanks in part to a development model based on debt: a very risky strategy favored by the same shadow banking system that has been betting on real estate for a long time – a category which has grown to just under 30 percent of China’s gross domestic product.

The fall of real estate developer Evergrande (for which a decisive hearing on the approval of its restructuring plan is scheduled on January 28) ushered in a crisis that has deepened in recent months, also involving Country Garden, the first private developer, which had always been thought to have a more virtuous model than its main competitor. Zhongrong, Zhongzhi’s operating arm, had shown early signs of distress in recent months, missing payments on more than 30 asset management products due to its controlling shareholder’s liquidity problems.

In November, authorities launched an investigation into “suspected crimes” perpetrated by Zhongzhi executives: an omen for the later bankruptcy filing. This might not be the end of the problem: despite recent attempts to extricate itself from real estate, the shadow banking system has reached about $155 billion in exposure to the various construction companies over the years.

The government is trying to manage the crisis. In 2023, Chinese provincial authorities pumped a record $31 billion into regional banks through special bonds. According to a number of analysts, the government might approve a maxi stimulus package in 2024, a move it has avoided so far. Then again, while the world was focusing on the warning signs about Taiwan, Xi Jinping did mention the difficulties of “some enterprises” and youth unemployment in his year-end speech. “Along the way, we are bound to encounter headwinds,” he admitted.

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