Embattled Beijing takes aim at underground banking

China has launched a three-month nationwide campaign against underground banks to crack down on money laundering and stem illegal capital flows in and out of the country.

China has launched a three-month nationwide campaign against underground banks to crack down on money laundering and stem illegal capital flows in and out of the country.

The campaign will focus on illicit fund transfers and money-laundering connected to corrupt officials and terrorists, the Ministry of Public Security said on its website on Monday. The crackdown, with immediate effect, will last until the end of November and is being instigated in the wake of the country's stock market turmoil.

Vice minister of public security Meng Qingfeng said in the announcement that underground banking activities had contributed to the disorder of the country’s financial markets. Meng also took charge of last month’s probe into “malicious short-selling” of stock and stock indexes.

“Some ‘grey capital’ has been transferred through underground banks across [China’s] border,” Meng said. “It not only poses a serious risk to China’s foreign exchange management but also disturbs the order of the country’s capital markets and threatens its financial security.”

JP Morgan strategists estimate that China experienced “remarkable” capital outflows of $340 billion in the year to end-June, with the second quarter of 2015 alone haemorrhaging $140 billion. “The magnitude and the duration of capital outflows are unseen in China,” they said in a note in late July.

Meng added that the ministry will dispatch special groups to regions where underground banks are rampant in order to squeeze “their living space” and force market participants to conduct financial activities through legal channels. 

The campaign was announced after China’s benchmark Shanghai Composite Index dropped 8.5% on Monday, its biggest one-day plunge in eight years – even the official Xinhua News Agency dubbed it Black Monday. The slump followed Beijing's surprise move to devalue the renminbi and poor manufacturing figures, which cast doubt on the Chinese government’s ability to manage the country's economic slowdown.

The People's Bank of China has now cut benchmark interest rates five times since November to try to stave off the risk of a harder economic landing, with Beijing's 7% growth rate target for 2015 under growing pressure.
Show of strength
According to Keith Pogson, senior partner (banking and capital markets), Asia-Pacific, at Ernst & Young, the launch of the campaign against underground banking shows China stepping up its efforts to maintain control of its economy and financial markets and reassure domestic and foreign investors.

“It is important at this point of time [for China] to demonstrate control,” he told FinanceAsia. “One of the reasons that the [Chinese] leaders’ control on the economy is getting weak is because it has been undermined by [uncontrolled] activities of shadow banking.”

“[The campaign] is an important message to send – we’re going to clamp down on the [underground banking] market. We want to take control,” he said.

Concerns over China’s sluggish economy – and expectations of the yuan’s depreciation ahead of a long anticipated hike in US interest rates  – have helped to spur a wave of capital outflows that has picked up speed in recent months.

To restrict the movement of capital and control the value of the redback, China has for years imposed an annual $50,000 cap on individual Chinese for funnelling assets out of the country. Many Chinese citizens have therefore resorted to other ways to spirit funds out of the country, including using underground banks, which have boomed in recent years.

The underground banks, which run in the twilight of China’s financial system, generally allow clients to purchase foreign exchange and illegally shift capital abroad through online and mobile payment devices.

In April, a similar campaign was launched by the Ministry of Public Security, the People’s Bank of China, and the State Administration of Foreign Exchange in a bid to clamp down on illegal fund transfers via underground banks and offshore companies.

The campaign demolished 66 underground banks and arrested 160 suspects responsible for illegally shifting about Rmb430 billion ($67 billion) out of China, the ministry said.

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