Lurking in the Shadows—The Risks from Nonbank Intermediation in China

By Nigel Chalk

(Version in 中文)

One of my all-time favorite movies is “The Third Man” starring Orson Welles and Joseph Cotten. It is a British film noir from the 1940s. Perhaps the most striking part of the movie is the shadowy cinematography, set in post-World War II Vienna. Strangely, it springs to mind lately when I have been thinking of China.

Many China-watchers looked on in awe in 2009 as the government’s response to the global financial crisis unfolded, causing bank lending as a share of the economy to expand by close to 20 percentage points in less than a year. This, subsequently, led to a lot of hand-wringing about the consequences of those actions and the eventual credit quality problems that China would have to confront and manage.

However, around the same time, a less visible phenomenon was also getting underway. One that, like Orson Welles’ character in the movie, resided firmly in the shadows. Various types of nonbank financial intermediaries—some new, some old—were gearing up to provide a conduit through which China’s high savings would be tapped to finance the corporate sector. The available data on this is terrible—the central bank’s numbers on social financing are the only credible and comprehensive public source, but even that gives only a partial picture.

Talking to people in China, and looking at what numbers are available, one cannot help but have an uneasy feeling that more credit is now finding its way into the economy outside of the banking system than is actually flowing through the banks.

The means by which such “lending” is being provided is wide-ranging and dynamically evolving.

Certainly many are aware of the high volumes of bankers’ acceptances—off-balance sheet short-term credit—being used of late. Over the past couple of years, trusts and entrusted lending vehicles (China’s own particular form of asset securitization) have also taken off. Then there is the world of informal lending: loan sharks charging high interest rates to those poor souls that are rationed out of regular channels of intermediation. The recent narrative from Wenzhou has certainly excited many.

But the shadows stretch even beyond these tales.

In the 12 months to June, over RMB 600 billion poured into China from short-term lending by nonresidents to Chinese corporations. Financial leasing companies have expanded, providing services that look a lot like credit by another name. The corporate bond market has blossomed, perhaps reaching RMB 1 trillion in new issuance for this year. There is an unknown volume of inter-corporate lending passing from one large company to another. And finally, some nonbank institutions have entrepreneurially moved into the lending space, providing loans to large corporations as a way to boost their profitability.

These developments are worrying for four broad reasons.

  • First, that’s an awful lot of credit. New bank credit alone is likely to be over 20 percent of GDP this year. This is already a very high number. However, if a similar amount (or more) is finding its way into the economy through channels outside the regulated banking system, this would add up to a huge amount of credit stimulus. This high level of credit, in turn, is facilitating a continued upward trajectory for investment which is fast approaching 50 percent of GDP.
  • Second, the regulatory oversight for these various intermediaries is likely to be nowhere near as effective and comprehensive as it is for the banks. We have seen this in many other countries—deposits and lending migrate out of the banking system because life is just easier there without those pesky regulators asking awkward questions about how risks are being managed. It often doesn't end well.
  • Third, if nonbank channels of intermediation develop at a faster pace than the banking system is reformed, the shift of resources out of the banks and into the shadows will progressively start to undermine the health and stability of the banks themselves.
  • Finally, and perhaps my largest concern. The rapidly expanding nonbank system is actively undermining China’s ability to exercise macroeconomic control. This, in large part, reflects the structure of the current system. China uses monetary tools like interest rates and reserve requirements sparingly and, instead, relies heavily on quantitative limits on bank lending to switch on and off the credit taps and manage the pace of economic growth. These bank-by-bank credit quotas create enormous incentives for intermediaries to find other ways to lend. By not actively using interest rates and price incentives to choke of the demand for loans, China is far too reliant on controlling the supply of credit. The more intermediation that takes place outside banks, the tougher it is to enforce the credit policy that is essential in guiding the trajectory of the economy.

Thankfully, China’s regulators are trying to pursue the problem. Last year they moved to require a large share of trusts to be brought back onto bank balance sheets and, more recently, the bank regulator has issued instructions to the banks to stop moving loans off their books and repackaging them into wealth management products.

Despite these efforts, this risks the regulatory authorities perpetually being one step behind the financial innovators, always patching up the last hole in the system.

What is needed instead, as we have argued for some time now, is a careful reexamination of the whole monetary and financial framework. Policies that restrain credit through administrative means are becoming increasingly difficult to sustain. It is only going to get worse. This has been the experience of every other country that has tried to exercise macroeconomic control this way. China, admittedly, has held the system together exceptionally well for many years and it is never wise to bet against the government’s ability to diagnose and successfully resolve problems as the economy develops and becomes more sophisticated.

That does not alter the fact, though, that China is now facing a clear choice: pursue financial and monetary reform on a timetable that is driven by careful, pre-emptive, and concerted policy planning. Or, face the possibility that change will evolve in an uncoordinated and disorderly way, with innovation and disintermediation outpacing supervisory capabilities and revealing regulatory gaps along the way.

At the end of The Third Man, Orson Welles emerges from the shadows and, unfortunately, promptly meets an untimely end at the hands of Joseph Cotten. It would be a major setback for China, and the global economy, if the long and proven track record of spectacular Chinese growth were to be undermined by waiting too long to make progress on financial liberalization and reform.

2017-04-15T14:16:08-05:00November 3, 2011|


  1. udonthaniblog November 3, 2011 at 4:07 pm

    I agree. I have watch this non-bank sector since the 1980’s from Taiwan to Thailand.

  2. FT Alphaville » Further further reading November 3, 2011 at 4:37 pm

    […] – Troubles in Chinese shadow banking. […]

  3. November 3, 2011 at 11:13 pm

    With reference to your middile paragraphs, most worrying to me are the emerging tales of things like “soybean banking” whereby importers are using their heads and gaming the system to capitalise on the potential to earn massive amounts in interest on the underground market.

    MofCom appears to have finally begun to see the risks:

  4. "Lurking in the Shadows…" | Financial Feeder November 4, 2011 at 12:07 am

    […] Tweet “…the Risks from Nonbank Intermediation in China,” by Nigel Chalk in IMFDirect.Many China-watchers looked on in awe in 2009 as the government’s response to the global financial […]

  5. George Naumovski November 4, 2011 at 1:18 am

    Banks will keep lending money! All financial institutes don’t care if you can pay the money back because it is not their money in the first place; they just want the interest to be paid as that is how they make their money.

    People are willing to sign life time debt to get what they want and government keep bailing each other out as passing the debt around.

    China is set to become the next super power and will stop at nothing to achieve that. China and India have the people and as their government treats its people as expendable and life is worth $0 so investments flow to China, they will keep doing the same thing over and over again because at the end of the day it is all never ending debt repayments if interest!

  6. Chris Ryan November 4, 2011 at 5:51 am

    Agreed… good to hear that they are addressing the problem

  7. […] Risks from Nonbank Intermediation in China,” by Nigel Chalk in IMFDirect. Many China-watchers looked on in awe in 2009 as the government’s response to the global […]

  8. […] Risks from Nonbank Intermediation in China,” by Nigel Chalk in IMFDirect. Many China-watchers looked on in awe in 2009 as the government’s response to the global […]

  9. "Lurking In The Shadows…" | My Blog November 4, 2011 at 7:34 am

    […] “…the Risks from Nonbank Intermediation in China,” by Nigel Chalk in IMFDirect. […]

  10. GS RADJOU November 4, 2011 at 10:34 am

    Hi, as long the rate is high, there are always intermediaries to lend for cheaper- and challenged banks

  11. […] admin  “…the Risks from Nonbank Intermediation in China,” by Nigel Chalk in IMFDirect. Many China-watchers looked on in awe in 2009 as the government’s response to the global […]

  12. […] View detail here: iMFdirect – The IMF Blog […]

  13. udonthaniblog November 4, 2011 at 3:54 pm

    “Dou Hu Banking”

  14. GS RADJOU November 4, 2011 at 3:57 pm

    Orson Wells is not too bad,… I love Sherlock Holmes

  15. GSRADJOU November 5, 2011 at 1:50 pm

    There is also, black markets to top up the shadow system….

  16. gsradjou November 5, 2011 at 4:07 pm

    I completely agree with you George, but banks care!

    What the history of bank lending of money tells-

    1- Normal practice:

    At the beginning, you have a bank, which takes people monies (customers),

    From time to time, customers withdraw their monies at it suits them
    But, not all customers withdraw the total amount,….therefore the bank Manager knows that he can use the remaining monies too speculate, lend, make transactions,…

    2- Risks:

    The worst that can happen is when all customers ask their money back at the same time,….my goodness for the bank, it hurts, it is when/where the crisis starts, banks are bankrupted –see my other post about banks being bankrupts,…

    In summary, banks need to adjust these interest rates to avoid these risks-
    (It is the money business with money supply and demands)

  17. Javed Mir November 6, 2011 at 10:44 am

    Non-banking financial intermediation if not properly managed definitely results in losses to investors generally to those who are not risk averse because of the premium they expect. Corporate culture in China is still in infancy. The informal lending can cause crisis like situation in China as we have experienced in the USA and European countries. The investors (resident or non-resident) who are investing in non-banking institutions of China should learn a lesson from the recent Occupy Wall Street movement.

    In order to manage the awful lot of credit (reported by Nigel), statutory oversight (on the pattern of IMF Surveillance Action Plan) needs to be implemented right from the inception, otherwise the situation might get out of control. Pesky regulators have to wake up. Procrastination can retard the presently enviable Chinese growth.

  18. GS RADJOU November 6, 2011 at 1:54 pm

    Is it on purpose? is it reaching a tipping point…?
    Intermediaries can have a much profitable business and fiancial management thazn the banks themselves- Is not it too good, False or true freedom claims of the banking system.

  19. Amir Dewani November 7, 2011 at 2:36 pm

    To the best of my knowledge the Chinese are better than us in managing their affairs – banking as well as financial.
    They are good not only at planning, organizing, target setting, controlling and evaluating performance of their banks, but also channeling credit in the most efficient ways. I am just asking: How many banks have failed in China during the past ten years, or twenty, or more?
    And look to the number of bank failures here — especially during the last four years since 2007. Around 450 0r more. On top is the most awkward bank failure of Lehman, not talking about the two big house building financial institutions of the USA.

    Look to the on going debacle of the big European banks of Germany, France, the United Kingdom, Italy, Spain, Ireland, Portugal etc, and the
    degraded credit ratings of scores of their banks and tell me who is better in managing banks?

    Don’t you remember the two failed stress tests of about 91 European banks? Don’t you remember the oft repeated advice given at the G-20 summits for banking reforms time and again?

    Under the circumstances, I feel it better to ‘mind your own business’, instead of worrying about the Chinese banking system. Volumes can be written about the points of comparison on economic growth of the emerging economies — BRICS — and the debt/deficit ridden big economies, but that is not the point here.

  20. gsradjou November 8, 2011 at 10:48 am

    It is chinese capitalism….

  21. gsradjou November 8, 2011 at 10:53 am

    Thanks to the U.S. financial crisis…

  22. […] Lurking in the Shadows—The Risks from Nonbank Intermediation in China […]

  23. Claude November 14, 2011 at 12:38 pm

    Please look at domestic credit to the private sector as a % of GDP (FS.AST.PRVT.GD.ZS)
    1. in 2010 it appears that a lot of countries have a far higher numbers than China and … Eurozone:
    USA 202% UK 204% Japan 168% Eurozone 133% China 131%
    2. Looking at the last 10 year dynamic: the UK is explosive, the U.S. not far from it; whereas the Eurozone as China show continued figures.
    May be the risks are more for the UK and the US than China (and eurozone). Is that right?

  24. GS RADJOU March 13, 2012 at 9:51 am

    A couple of new points:

    1. China — and not Beijing or Hong Kong, Guanzhou, Shanghai — has a long way to go; not Beijing or the eastern coast of China, including Hong Kong. The real China with over 100 nationalities, including Tibet, Xinjang, has more people than Europe and America combined and the rest of the world still does not know their progress status.
    2. $2,000 to $4,000 billion saved by China during the crisis. Is not that the equivalent of what U.S. tax payers paid for one or two years to the federal budgets during the crisis?

    In summary, congratulations to China for their opportunity management during 2007-2009 financial crisis.

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