Sunshine Despite Fear of Shadow Banking in China

TAIPEI (TheStreet) -- China's shadow banking field has cast a dark spell over markets as high-profile defaults become more common. Collapses of investments arranged through private trusts are spreading, making investors distrustful of China.

I'm stepping into some shadowy territory here, but I forecast the problem will fade, with little impact on capital markets.

Shadow banking, although around for a while, came to the world's attention last year. This month, when it turned out that products totaling $126 million issued by Jilin Province Trust in northeast China couldn't repay investors, some analysts started warning against positions in Chinese equities. The same trust and six others also had lent money to a defunct coal company, raising fears of a wave of new defaults.

"Unfortunately, due to a lack of transparency and the extremely complicated system, even well-informed global investors cannot grasp the true nature of China's financial difficulties," Nikko Asset Management of Japan said in a Jan. 30 research note. The note advises caution toward Chinese equities because of shadow banking risks, including government intervention that could dry up liquidity.

Investors presumably would get scared of a long-term, systemic problem and pull money out of Chinese markets to avoid being burned by companies nearing default. Poor sentiment onshore could leech into China-linked shares overseas, even well-run companies such as PetroChina Co. (PTR) and China Life Insurance (LFC).

But Nikko also points out a detail that lets you at least flip a coin about whether the issue will overshadow market performance. Defaults of several property trusts were settled because of rising land prices and "generous credit," its report says.

Look at this case, as told by the official Xinhua News Agency. In January, the news agency said, China Credit Trust reached a "last-minute deal" with investors to repay a $500 million investment in a mining operation that used the money to get loans it ultimately couldn't pay back. About 700 clients of the Industrial and Commercial Bank of China (1398.HK) had made the investment in the eventually bankrupt Shanxi Zhengfu Energy Group.

That deal eased "concerns that default would pound investor confidence in shadow banking and trigger credit crunches," Xinhua said.

Defaults, we might suppose, aren't so bad. There's always a way out of the shadow.

They're also rare compared to the amount of lending in China. In 2012 just 0.27% of trust products faced "repayment difficulties," the Mingtiandi real estate newsletter says on its Web site this month, citing data from the China Trustee Association.

Lending grew an unusually fast 18% in January, UBS Bank notes in a Feb. 17 report. Assets in China's trust industry went up 46% last year to $1.8 trillion, Mingtiandi says. These numbers don't depict much fear.

China's tough talk about cleaner shadow banking could hit liquidity again as it did in mid-2013 and last month. But the government knows its economy -- still led by manufacturing and infrastructure despite endless gab about reforms -- needs investment, meaning new loans. Given government support for loan-driven investment, any central bank squeezes are likely to be episodic rather than routine or long term. The biggest risk may be volatility, not a sinking of the markets.

"We are...more concerned about credit volatility triggered by renewed bouts of liquidity squeezes, a tightening of shadow credit regulations, or more importantly, any potential credit defaults in the shadow credit market that could lead to a temporary shrinkage of certain credit markets," the UBS report says.

At the time of publication the author had no position in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

If you liked this article you might like

Wall Street on Track for Records as Energy Overshadows Telecom Pressure

Wall Street on Track for Records as Energy Overshadows Telecom Pressure

Energy and Chipmaker Stocks Lead Wall Street Above Record Closing Levels

Energy and Chipmaker Stocks Lead Wall Street Above Record Closing Levels

Healthcare Drives Small Gains for Dow While Rest of Market Slips

Healthcare Drives Small Gains for Dow While Rest of Market Slips

New Records for Dow, S&P 500 and Nasdaq as Apple's Gains Offset Healthcare Slide

New Records for Dow, S&P 500 and Nasdaq as Apple's Gains Offset Healthcare Slide

Dow, Nasdaq on Track for Records as Energy and Apple Rise

Dow, Nasdaq on Track for Records as Energy and Apple Rise