The Shadow Iceberg

Beijing’s deleveraging campaign has produced a meaningful contraction in overall shadow banking activities. Asset management rules designed to limit high-cost wealth management products (WMPs) have reduced banks’ claims on shadow lenders by 3.4 trillion yuan in the first two years of a three-year program. This contraction in financing has produced corporate bond defaults, which can be monitored. However, defaults on shadow banking products are also increasing and harder to see, representing a hidden iceberg of credit risks.

To shine some light on this problem, we attempted to construct a database of defaults on trust loans and trust products, using available data and some estimation techniques. The number of defaults is fairly large, around 1.4% of trust products that matured last year, but the database is necessarily incomplete given the private nature of these products and limited information disclosure. In addition, we reviewed last year’s asset growth among all non-bank financial institutions (NBFIs) and reached the following key findings:

• Shadow banking investment product and loan defaults are increasing. This is predictable given the slowdown in the economy and shadow credit channels, and defaults can be seen within trust products and asset management firms.
• Deleveraging will continue this year, despite the easing credit environment. Trust loans remain a focus of Beijing’s deleveraging campaign, evidenced by new draft CBIRC regulations targeting the sector.
• Property developers face the greatest pressure from continued contraction of shadow banking channels. Developers’ exclusion from REITs, especially small developers without access to official funding channels such as bank loans or bonds, will leave them exposed to contracting shadow financing activity.