In a recent meeting of the Chinese Communist Party’s Politburo, President Xi Jinping appointed a new banking regulator chief to oversee the country’s troubled financial system.
For decades, the world’s second-largest economy reaped the benefits of over-leveraging, investing heavily in infrastructure and property projects to help boost the overall GDP. However, with debt levels in China climbing at an alarming rate, many economists fear that the country’s credit growth is quickly approaching levels that are typically followed by recessions in most emerging markets.
Guo Shuqing, who was officially named the chairman of the China Banking Regulatory Commission on Feb. 24, spent the majority of his career in the financial industry. In his previous role, Guo battled insider trading, market manipulation and other fraudulent activity in China’s stock markets as the head securities regulator. Guo’s appointment comes at a critical time when the country’s debt problem is at record highs.
According to a post on the Federal Reserve Bank of New York’s blog, titled “Liberty Street Economics,” China is responsible for nearly half of all the global debt created since 2005.
The blog states, “nonfinancial debt in China has increased from roughly $3 trillion at the end of 2005 to nearly $22 trillion, while banking system assets have increased six-fold over the same period to over 300 percent of GDP. In 2016 alone, credit outstanding increased by more than $3 trillion, with the pace of growth still roughly twice that of nominal GDP.”
One of the main drivers of China’s credit growth is related to the surge in bank lending following the global financial crisis. In addition, shadow credit, which has grown to become an integral part of the loan activity in the country, introduced new investments that are more uncertain and have a higher chance of default than normal loans. Shadow banking helps corporations in riskier sectors that have strict borrowing requirements take out credit “in the form of trust loans, entrusted lending, and undiscounted bankers’ acceptances.”
Furthermore, banks in China have increasingly relied on short-term investment products that are less stable to help finance their operations. This type of borrowing raises liquidity risks that could surface any time. Wealth management products, which have grown by $4 trillion or 37 percent of GDP since 2011, were reported as the biggest liability for the banks last year.
With each additional yuan of credit proving to be less effective to overall growth, new reforms will need to be implemented to minimize the bad loans and reduce the inefficiencies in the market. An article posted by the China Daily in May 2016 reported that China is taking serious measures to clean up its unprofitable state-owned enterprises known as “zombie” companies. Under the current plan, China will look to clean up as many as 345 of these companies over the next three years. In addition to this effort, the government has made plans to target lower output in its sectors suffering from overcapacity. These initiatives, along with a new regulator to lead them, will allow China to lift some of the burden that has weighed down its economy over the years.
Despite China’s predicament, there are several features in its financial system that make the massive debt figures not as bad as they seem. The government’s strong balance sheet suggests that the country has the resources to sustain itself in the wake of a financial crisis. However, China’s complex banking system makes it too difficult for anyone to estimate the actual level of debt within the country.