China’s shadow-banking industry threatens its financial system

livemint.com:

weaker than expected, and property developers are caught in an unprecedented wave of defaults and restructurings. China’s trusts, which channel funds from investors to infrastructure, property and other opportunities, are exposed to both developments. Although Xinhua’s bankruptcy has been relatively straightforward, a bigger blow-up may be on the way at Zhongrong, one of the country’s largest trusts, which missed payments to clients in mid-August.

Panicked investors fear more firms will be ensnared, and that collapses will lead to further economic problems. During China’s years of strong economic growth, trusts and their investors flourished, with investment products often offering annual returns of 10% or more. Property developers and local governments were willing to pay lofty interest rates, transactions faced less regulatory scrutiny than bank lending and trusts benefited from the widespread perception that investors’ cash was safeguarded by the state in a fashion similar to bank deposits.

That perception is now long gone—and as more developers default, it is likely that more shadow banks will be unable to pay out. Zhongrong, which managed about 630bn yuan in trust products at the end of last year, shows how pain has spread from the property industry to the financial system. When Sunac, China’s fifth-largest developer, defaulted last year, local governments began freezing company funds in order to ensure projects were finished.

One of the locations where funds were frozen was Wuhan, a city in central China, and the money included investments linked to Zhongrong. Across the industry, about 7% of trust products were invested directly in the property sector at the end of March. Indirect investments via securities push