Thursday, December 8, 2016

Shadow Banking Hides Bank Loans

Shadow banking is in focus again as banks try to hide loans from regulators. Large business and real estate loans by Chinese banks have come under heightened scrutiny with regulators and central planners trying to rein in a two-year credit binge. Banks have responded by setting up shadow companies in order to disguise some $2 trillion in loans as investments. In this scheme, the bank records its interest as an investment in a shadow banking fund or company. The fund, in turn, holds the loans to real estate developers, factories, importers, and other borrowers. It’s a mechanism for banks to get around reserve requirements by reclassifying loans as investments. This is laid out in detail in the Fortune story “China’s Credit Binge Has Driven Its Banks to Hide $2 Trillion in Loans” [ ]. The off-balance-sheet risks make the financial system more brittle at a time when the central bank has promised there won’t be any bailouts.

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