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Default looms in China's 'shadow banking' system

SHANGHAI--A shockwave is looming in China's multitrillion dollar “shadow banking” system, with an unprecedented default only days away on a US$500 million investment product sold to hundreds of people.

Staff at China's biggest bank ICBC pushed the “Credit Equals Gold #1 Trust Product” by promising returns of 10 percent a year, far more than traditional deposits, investors say.

But the coal company it was supposed to fund never obtained key licenses for its activities, state media reported, and now the firm that structured it, China Credit Trust, says it may not be able to repay 3.0 billion yuan (US$492 million) due on Friday.

The situation is a test case for cleaning up the risky “shadow banking” system in the world's second-largest economy.

Analysts said the government could use a default to send a message about the danger of speculative investments, while showing Beijing's commitment to reining in the vast pools of capital threatening financial stability.

But at the same time authorities must walk a fine balance between cracking down and preventing protests by angry investors — as well as setting off a chain reaction that sharply tightens credit in an economy where growth is already slowing.

Chinese “shadow banking” is a massive network of lending outside formal channels and beyond the reach of regulators, including activities by online finance platforms, credit guarantee companies and micro credit firms.

It was as large as US$4.8 trillion in 2012, more than half the country's gross domestic product, according to an estimate by ratings agency Moody's.

China's powerful State Council, or cabinet, reportedly issued internal guidelines in December to crack down on the sector.

But ratings agency Fitch said in a report: “The reforms may seem like a good beginning, but they have a long way to run.”

China Credit Trust sold the investment product from 2010 through branches of the Industrial and Commercial Bank of China (ICBC), to around 700 of the bank's high net worth clients.

The trust channeled the funds to Zhenfu Energy in the country's mining heartland of Shanxi province. But the company's owner was detained by authorities in 2012, state media reported, raising questions over the viability of the firm.

“ICBC and China Credit Trust dug a hole, covered it with a straw mat and told us to jump in,” said Gao Yiyang, an investor who spent almost US$500,000 of his family's money on the product.

“It now appears our money was not used for any of the company's actual operations. It was purely fraud to get our money to fill a huge deficit hole,” he told AFP.

In a letter sent to investors earlier this month, a copy of which was seen by AFP, China Credit Trust said: “Currently, there is still uncertainty over whether the trust can be converted to cash before January 31.”

Products sold by China's roughly 65 trusts offer high returns and big risk, drawing comparisons to the West's “junk bonds” of the 1980s.

“Some central government-level policymakers could be open to seeing a default, as it would encourage more careful risk assessment,” Goldman Sachs economist Andrew Tilton said in a recent research report.

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This picture taken on Saturday, Jan. 25 shows a man and a woman making their way with bags along a commercial street in Beijing. (AFP)

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