Note: This will be the first of a three part series addressing the risks to Chinese economic growth.
On The Surface
With China’s GDP growing at an average of 10 percent per year between 1978 and 2011, it has become a giant in the global economy. In recent years, though, China’s average GDP has declined to 7%. While the stagnation of such rapid growth is to be expected, the rate of decline caused by predatory banking practices might foreshadow economic recession.
“Shadow Banking” describes bank activity (lending, deposits, securities) that does not appear on bank balance sheets or on any database. This practice exploded in popularity when traditional banking through the People’s Bank of China (PBC) could not meet demands in the face of a skyrocketing economy.
Shadow banks are difficult to regulate, due to the aforementioned lack of records. Additionally, shadow banks have no obligation to provide the safety net that traditional banking provides. This lack of a safety net and of regulation is troubling considering that Chinese shadow banking now is the third-largest shadow banking sector in the world.
Microfinancing is a form of shadow banking, providing micro loans to encourage credit access for both rural businesses and home owners. The small size of these loans makes them hard to track (which is why microfinancing is a form of shadow banking).
While microfinancing loans lack deposit security, loan insurance, and other important financial guarantees typically provided by the PBC, the main concern is the reckless loaning that microfinancing firms participate in. While these loans are small, the sheer number of loans given out is troubling.
Such practices often lead to instability that cripples economic growth. What’s more, the issues with microfinancing are now being amplified by China’s monumental demographic shift. Millions of Chinese pouring into urban areas on the East coast have created a massive demand for microfinancing firms, and these firms are doling out millions of loans without question to every rural entrepreneur seeking to open up a corner market or restaurant. The real issue at hand is that many of these rural entrepreneurs are unable to pay off these loans, leading to both bankruptcy and poverty issues.
Thus, while the Chinese economy’s rapid growth has started to level off, the emergence of shadow banking and predatory microfinancing loans will leave millions without financial security if left unchecked.