Flourishing Shadow Banking Poses Risks to China and India's Stability
December 20th, 2012 by Sheridan Prasso
Regulators fear that the amount of money put in private banking in China is creating systemic risks. (omefrans/Flickr)
In Asia, hundreds of billions of dollars exchange hands through shadow banking, beyond the reach of government regulators who have little idea of the full scope of the financial activity going on in their own economies.
This private lending between friends, acquaintances, communities and clans — along with off-the-books funds, trusts and alternative investments — constitutes a nebulous world that the Financial Stability Board has blamed for creating "systemic risks" to global financial stability.
The largest economies of Asia, China and India, are where the underground financing industry is flourishing. Its size means government policy makers have a more difficult time using the usual levers of monetary policy — such as changing interest rates — in order to control inflation and spur GDP growth. The proliferation of investment funds outside of government hands also means that if a massive economic downturn causes these investments to go bad, it's nearly impossible for the government to intervene, such as the U.S. did in a massive bank bailout in 2008. In these economies, there's no central place to put the money.
Some key facts reveal the reasons behind, and risks involved in, this shadowy world:
Shadow banking flourishes because more than 92 percent of the country's 42 million small businesses can't get bank loans, and because interest rates paid by banks are held artificially low by the government.
More than 376,000 lawsuits were filed over private-lending disputes in the first half of 2012, totaling $17.65 billion.
Thousands of shadow bankers who took money from friends and acquaintances have fled, committed suicide or declared bankruptcy, leaving untold numbers of victims who've lost their savings.
China has sentenced to death at least 17 people, including a young woman known as "Rich Sister," for illegally collecting investments and not paying back.
The estimated size of shadow-banking activity, $3.35 trillion, is about 45 percent of the total economy.
Trusts, where millions of Chinese put their money when seeking alternatives to bank accounts that pay low interest rates, are the fastest-growing segment of shadow banking. They face risks of default due to a decline in the property market where they're invested.
China now has more than 2,000 peer-to-peer Web sites where people lend to strangers online.
India has the second-fastest growing shadow-banking activity in the world, after Indonesia.
Some 65 percent of Indians don't have access to bank accounts and have to rely on shadow banking to lend, borrow and save.
More than 92 percent of small businesses also can't get loans from banks or don't try.
The official $670 billion total for non-bank lending and investment companies doesn't count private lending, 10,000 registered community chit funds, or individual gold holdings. With so much of India operating in the "black economy," shadow banking's true size is unknown and can't be estimated.
When policy makers raised interest rates 13 times between March 2010 and April 2012 to try to lower inflation, it still stayed stubbornly high. That's because finance companies aren't banks and don't have to listen.
Millions of Indians are willing to pay private lenders double the interest rates banks charge in order to get quick loans by giving their gold jewelry as collateral.
Scams proliferate. More than 22 million investors are to get their $3 billion back after the Supreme Court ruled that Sahara group must repay them, with 15 percent interest. In Tamil Nadu, 6,000 people complained to police after losing their money by investing in emus.
Sheridan Prasso, based in Hong Kong, is an Editor-at-Large for the Asia-Pacific region at Bloomberg News, specializing in in-depth coverage, particularly of China, India, and Japan. She is an Asia Society Associate Fellow.
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