By the Blouin News Business staff

China shines a light into its huge shadow banking system

by in Asia-Pacific.

Bank of China building in Beijing

Photo Credit: AFP/Getty Images/Liu Jin

In January, we highlighted how policymakers in Beijing were increasingly concerned about the systemic risks posed by China’s burgeoning shadow banking system. Now China is tightening its regulation of these huge credit flows beyond the formal banking system, the Financial Times reports.

Banks will reportedly be required to provide fuller disclosures about their off-balance sheet investment products, sold to bank customers as wealth management products, and may face a cap on the percentage of their assets such products can account for. An estimated 10% of all bank deposits are now funneled into them.

The shadow banking system has quadrupled in size since 2008 and at $3.2 trillion is equivalent to 40% of China’s GDP. As we said in January, there have been a string of recent problems with wealth-management products, each small in itself but collectively an alarming preview of what could happen on a far larger scale. Doubling regulators’ concerns is that these these products are often wrapped up with local governments’ off-balance-sheet financing that is used to get around formal controls on their finances, raising the specter of a second fuse to an already ticking local government debt bomb.

Policymakers don’t want to end this lending — shadow banking is fulfilling a need the formal state-bank dominated banking system is not, and doing so in market-based ways that financial reformers have been pushing for. But because it operates in regulatory grey areas there are potentially huge risks to financial stability. Policymakers want it out of the shadows and into the light where they can monitor and check it.