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Monday, August 26, 2013

China's Shadow Banking System a Growing Concern

Recently, several media outlets, including the Wall Street Journal, Reuters, and Bloomberg, have drawn attention to the problem of China’s “shadow” banking system. China’s official deposit rate is the interest rate Chinese banks pay on deposits. Because Chinese inflation tends to run well above American rates, Chinese savers worry that the official deposit rate will fail to keep pace with inflation, in which case their savings would effectively be eroded. China’s shadow banking system is essentially a system in which businesses (often small and lacking political connections) and individuals obtain loans from banks, trusts, and securities brokerages at high rates of interest. The interest rates on these loans greatly exceed the official deposit ate because they are purportedly not deposits. For instance, a person might deposit their money with a brokerage company with the expectation that the brokerage company will pay a high interest rate on it. The brokerage company might justify exceeding the official deposit rate on the ground that the person’s deposit is actually a private wealth management investmen

The shadow banking system is especially popular at the local level, because the regulated banking system often favors large, centralized enterprises or politically-connected individuals. However, China’s Politburo, the group that oversees the Communist Party of China, is unhappy with shadow banking because it believes the system fuels a misallocation of resources and “bubbles,” especially in real estate. Many Chinese savers, wary of the value of currency against inflation, purchase real estate, not so much as an investment as a store of value.

To combat the shadow banking system, China’s central bank withheld funds from the country’s banking system in June. The ensuing liquidity mini-crisis drove overnight lending rates between banks up to more than 13 percent, a jump of more than 10 percent from the previous month. However, the Politburo evidently meant only to issue a stern warning rather than a permanent policy change, as that rate fell to 3.4 percent in early July as the central bank resumed lending.

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