Efforts by China´s financial authorities to tame its real estate sector failed, mostly because China´s investors have few venues to make money, says shadow banking expert Sara Hsu in the EastAsia Forum.
Government involvement in the shadow banking sector is unclear. In the past, authorities have bailed out failed products such as WMPs, but bailouts are far from guaranteed. Neither is the enforcement of interest, as illustrated by a recent case where New China Trust — in an attempt to recover equity investment from a real estate developer — lost a lawsuit. The equity investment was viewed by industry experts as a loan, since it contained a stock repurchase agreement. But the courts did not support this understanding. Inconsistent bailouts and insufficient support for shadow banking interests renders investment in this sector risky and uncertain.
But a lack of alternatives has made the shadow banking sector a go-to resource for borrowers and investors alike. The stock market volatility that rocked China in June 2015 still resonates and investment in stocks has not fully recovered from the freefall that took place as the asset price bubble burst. Bond markets are shallow and corporate bonds tend to be overrated. The banking sector is associated with low returns on deposits and is also constrained in lending — it continues to prefer state-owned and larger firm borrowers at the expense of private and smaller firm borrowers.
China’s efforts to liberalise its financial sector and further open up to market forces have been marginally successful but insufficient in the face of increasing demand for returns and loanable funds. Firms and residents are increasingly financially savvy and wish to reap returns on their savings, but this is especially tough in an economy where interest rates and risk ratings do not always reflect real alpha and beta. As a result, we can expect to see asset price bubbles recur. The shadow banking sector will continue to grow in a climate that is failing to integrate market forces into financial products.
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