It sometimes feels like the whole world is bracing for the financial crisis to re-emerge in China, like a fresh outbreak of Sars.
But, as the 5th anniversary of Lehman Brothers’ came and went at the weekend, Chinese economists say they are convinced a bank default on such a scale will not happen, in spite of fears of a swelling shadow banking industry.
Broadly, the collapse of the US bank, and much of the chaos that followed, was caused by massive lending of banks backed by property mortgages, which were later leveraged, transferring risks to other parts of the financial system.
Meanwhile, regulators, led by the Federal Reserve, wrongly believed that if they fostered a low-inflation environment, markets could sort things out by themselves.
On September 15, 2008, Lehman Brothers announced its bankruptcy with a debt of $613 billion, triggering a domino effect that plunged many other US financial institutions into jeopardy.
This forced government-brokered bank mergers, wholesale rescues, outright collapses and the supposed re-imagining of the entire global financial system.
Five years on and there are concerns that the global economy is vulnerable to more shocks; this time from Asia.
If slowing Chinese growth was not enough to spook economists; concerns of a massive property bubble, an explosion of bad loans and the emergence of, according to some, a highly unstable shadow banking industry have led parallels being drawn with 2008.
However, such concerns are over-estimated, economists have told FinanceAsia.
“China’s financial system is not as leveraged as the US’s was before the financial crisis,” says Andy Xie, an independent economist who successfully predicted the Asian financial crisis of 1997. “Leveraged products will involve many financial institutions such as banks and insurance companies, which means one default of a heavy derivatives-holder will lead to a chain reaction and a systematic unbalance. This is not happening in China,” he adds.
Xie also pointed out that, unlike the US, China’s big banks are all state-owned and therefore investors are much more confident that banks will not default. This is important in considering the part the run on banks played in exacerbating the problem in the US and elsewhere in the west.
Some banking analysts do believe that China’s expanding trust industry is in a similar situation to Lehman’s five years ago, and has some risks. However, the industry is now under highly strict regulation and the trust products target a handful of big institutional investors who can afford risks of a default.
Another reason China should avoid the fate that befell the US banking system after Lehman is because of Lehman.
“The Lehman case of course can educate China in a technical level,” Cao Yuanzheng, chief economist with Bank of China, told FinanceAsia.
Mr Cao, who also believes China will not be faced with systematic financial crisis, said the government would inject liquidity if the inter-bank system experienced defaults.
“For some individual financial institutions, we can allow their bankruptcies and do not need to save them,” says Cao. “It’s all about how government will help the troubled financial institutions and that’s the lesson from Lehman Brothers.”
According to Cao and Xie, such institutions include trust companies, city commercial banks and the others that are not included in the financial clearing system.
Xie suggests that, if a non-systematic important financial firm crashes, the government should set up a special team to handle the issue and let investors pay for the loss, in an effort to avoid risks spreading to the whole banking system.
Of course, such a response was seen in the US, where the taxpayer ultimately paid to bail out the country’s financial institutions.
Although economists may play down the risks, investors provide the litmus test as to how such a crisis might play out. And many find worries about China’s credit problem not without grounds.
Moody’s Investors Service in May estimated that the size of China’s non-bank credit inter-mediation totals Rmb35.5 trillion ($5.8 trillion) as of the end of 2012, translating to 66% of 2012 GDP. Core shadow banking products - those that are relatively non-transparent, loosely regulated and carry elevated credit risk - amounts to Rmb21 trillion as of the end of 2012.
Meanwhile, the volume of local government debt, which is supported by overpriced land and property, stood at Rmb10.7 trillion at the end of 2010, according to Zhu Guangyao, China’s vice Finance Minister. The second round of audits this year may see the total volume rise “a little bit,” Zhu told media last week.
“The size of the shadow banking is massive, and the country can’t afford the $10 trillion local debts if they break out. It’s a big risk,” says Xie.
As China’s banks have significant exposure to shadow banking activities through their involvement in wealth management products and lending to companies and individuals that are active in shadow banking, the banking system will have more direct and indirect risk exposure, according to the Moody’s report.
"As a shadow banker,I acknowledge that shadow banking can undermine the formal banking industry," said Joe Zhang, a former UBS banker and now chairman of Wansui Credit in Guangzhou, and author of Inside China's Shadow Banking: The Next Subprime Crisis? in a speech in Hong Kong in June.
Despite Basel III, new financial controls introduced in the wake of the financial crisis, the banking system in China feels more fragile than before. The June’s credit crunch is an example how Chinese banks lost their last resort when the government was less willing to help out.
"Forget the technical nuts-and-bolts of the interbank market; what I see in China is a banking sector that has expanded credit much too quickly,and some banks have been caught in a maturity mismatch," says Zhang.
And the crunch surely has raised the alarm to the Chinese regulators in terms of their need to control the risks of booming credit.
Beijing is reviewing the local-government debt to assess risks to its financial system, and the results are expected to come out next month, ahead of a Communist Party meeting in November to set economic reforms, according to mainland media.
“(However,) history is repeating itself all the time. Maybe it’s too early to say the Lehman collapse has given enough lessons to China,” says Xie. “The Chinese government, like any other government, is short-sighted. But it has its own way out of another financial crisis.”