Comment by stjeanluc

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stjeanluc
February 20th, 2014 at 9:35 am

A good article about China shadow banking:

http://qz.com/175590/five-charts-to-explain-chinas-shadow-banking-system-and-how-it-could-make-a-slowdown-even-uglier/

The government has been threatening to crack down on the shadow lending that’s fueled by these WMP investment flows. And with good reason; the shadow sector enables wasteful, overly risky lending that ups both the risks of a financial crisis and the likely impact if one hits. But Pettis argues that plugging up shadow channels could come with unintended consequences.

“These same mechanisms will force the PBoC into unplanned ‘tightening’ as it takes steps to regain control of the shadow banking system,” he writes. “The net impact is to imbed a highly pro-cyclical mechanism into the national balance sheet that, like all pro-cyclical mechanisms, will increase volatility both on the way up and on the way down.”

In short, adding funds to the WMP channel has been making credit grow at a higher-than-normal multiplier—and for long enough now that it’s become the norm. Blocking that channel would therefore arrest the pace of credit growth that China’s financial system has long since become used to. If Pettis is right, in order to offset the rapid slowdown in credit growth, the government will need to loosen monetary conditions to allow more official lending at the same time as it cracks down on shadow lending. The People’s Bank of China has the tools to do this, but if it wrongfoots the timing, the bad times ahead are likely to be much worse.