Think of the words shadow banking,
and you'll probably conjure up an image of a slick-suited,
smooth-talking mafia-esque character who will most likely be found in
seedy bars or night clubs.
But in China, sometimes it could be a 60-year-old woman running the show, and that may have serious consequences.
This
week, state media reported that a clampdown on shadow banking in China
uncovered $30bn (£23bn) worth of illegal banking activity. It may seem a
staggering figure, but analysts say this is just the tip of the
iceberg.
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So what is shadow banking?
Michael Pettis from Peking University has described it as
"the financial activity that exists outside the formal banking sector".
In
its most basic form, it includes pawn-shops, the man on the street
offering you ready credit at exorbitant rates, and attractive but risky
investment schemes.
It also encompasses unregulated wealth management products offered by legitimate financial institutions.
But a substantial part of the sector also includes individuals or informal networks with no financial licence or regulation.
How did it grow so fast?
Informal
lending has always existed in China's economy, but shadow banking
really took off post the global financial crisis in 2008/2009.
These
unregulated lenders offered alternative options for small and
medium-sized businesses and real estate developers to get access to
loans during what could have been a crippling credit crunch.
Chinese authorities turned a blind eye to them at the time, because they were arguably helping the economy to keep growing.
But
as with many industries in China - such as the internet, for example -
things only start getting regulated when they get very big and start
getting noticed. And that's exactly what's happened with shadow banking.
How do they work: The 'gangster granny' case study
Amongst those arrested in China recently as part of what has become an ongoing crackdown on illegal banking is a
woman named only as Sun.
The Shanghai Daily says Mrs Sun is 60 years old, although other media outlets haven't said how old she is.
She
reportedly led a local gang and provided shadow banking services to
about 100 customers who wanted to buy real estate abroad or pay for
their children's school fees in foreign countries.
Police reportedly said it was the largest illegal banking operation found in Shanghai in years.
And
here's how it appears to have worked: Mrs Sun's customers sent her
money transfers in Chinese yuan. She and her network of agents then
transferred an equivalent amount in foreign currencies to their foreign
accounts, or wherever else the money needed to go, through a remittance
channel that operated outside the official banking networks.
The authorities suspect there could be many more such financial illusionists.
So who would turn to shadow banking?
Because
it is an unregulated industry, it's hard to say definitively who uses
them, but it appears that Chinese companies, corrupt officials looking
to move their money overseas, local governments interested in higher
returns and the Chinese middle classes have all invested in the shadow
banking sector.
Part of the problem is that if you're looking to grow your investments in China, there's not much you can do these days.
There aren't that many financial products the Chinese can invest in.
Authorities are trying to develop China's financial sector, but it's
still a relatively new and young market, and investors don't have that
much financial knowledge yet.
So what options are you left with?
Well, the stock market - but it crashed last year, and although it's on its way up again, many investors have been burned.
The
property sector - it also crashed, so people are understandably
nervous. Plus you need a large amount of money to start investing, and
it's an illiquid investment.
Saving your money in banks - interest rates have been cut frequently so you're not going to get very good returns.
So shadow banking which offers much higher returns is appealing - but it is risky, because it is unregulated.
Another
compelling reason is that mainland residents can only change up to
$50,000 worth of foreign currency per year, which makes it tricky if
you're looking to fund a big purchase overseas.
And then there's
the greed and envy factor. China's become a rich country in a pretty
short space of time. And everyone wants to keep up with the Joneses.
You
know how it goes. Your mate, let's call her Tina, gets a raise. She
starts investing some of her savings. Then she takes you out for a drink
and shows off her brand-new watch and tells you all about the holiday
home she's buying - and the fantastic new investments scheme that's
paying her some ridiculous return that's allowing her to do this.
And you get sucked in. That's how shadow banking can take off.
Why crack down on the sector now?
Chinese
authorities are in the midst of a concerted effort to clamp down on
individuals and organisations that are trying to take money out of the
country, because of concerns over capital outflows and the weakening of
the Chinese yuan.
But in turning a blind eye over the last decade,
China has allowed the creation of a financial monster that many warn is
out of control.
Moody's Investors Service says that the shadow
banking system continues to expand rapidly, with assets held by these
less regulated banks totalling some 78% of China's GDP.
And in
its annual review of the Chinese economy, the International Monetary
Fund recently said that almost half of the shadow banking products that
have fuelled China's credit boom carry "an elevated risk of default".
Notwithstanding
that China's economy is managed differently from that of other
countries and that the government can step in and bail the sector out,
if it comes to that, this is still very worrying.
This isn't just
a problem for the Chinese authorities. It's a problem for the "gangster
grannies", the doting grannies, China's middle classes and all the rest
of us.
Because if China's credit boom can't be relied on, that
means China's economic growth is at risk - and that's bad news for us
all.
