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What is Greatest Global Risk Lurking in Shadows? Look East

Posted by Larry Doyle on January 17, 2014 6:37 AM |

What is the greatest risk within the global financial system currently?

That is a question that could likely be answered with as many opinions as there are global financial sectors. Yet that was a question posed at a recent lunch I attended.

An individual who is highly respected within the industry and who has his pulse on much of what transpires within global finance opined that he believed the risks within the shadow banking sector in China would be the linchpin for our next market meltdown. I found that to be a fascinating insight as I thought about how much or perhaps how little people truly know about this space.

Well, I open the Financial Times this morning to see this lead headline: Chinese Shadow Banks Face Major Test >>>>>>>>>

China’s vast shadow banking sector is facing its biggest test after ICBC, the world’s biggest bank by assets whose branches sell many of these wealth products, refused to bail out investors in a dud $500m issue.

The enormous growth of poorly regulated financing outside the formal banking sector in China and the potential for a panicked run on these shadowy products and institutions poses one of the biggest risks to the global economy this year.

Interesting. Remind you of anything? Like sub-prime products originated by bucket shops and distributed through an array of questionable financial transactions on Wall Street.

Shadow banking worries extend far beyond China. Paul Tucker, a former Bank of England deputy governor, claimed on Thursday that regulators around the world were struggling to keep up with the pace of change in the “shape-shifting” non-bank sector. He warned of “faltering vigour” in official oversight of global markets.

“Faltering vigour?” As in perhaps limited or no meaningful investor protection from financial cops in bed with their government and industry friends? Haven’t we seen this movie before?

In China investment trusts and other wealth management products have become a vital source of off-balance sheet funding, and now account for almost a third of total credit in the world’s second-largest economy, up from less than a quarter in 2012.

Sounds like a whole lot of financial engineering undertaken to keep the game going. Anybody concerned about quality controls?

In China the funds are often invested in more troubled sectors of the economy and they have been snapped up by retail investors seeking better returns than those afforded by bank savings.

Most wealth management products are sold with some form of bank guarantee, leading many investors to believe that the products are effectively risk-free, despite the often high promised yield.

Sounds like the old ‘something for nothing’ trick or what those of us in these parts knew as AAA-backed sub-prime CDOs. We know how those worked.

“In the past we’ve had several examples of trust companies bailing out investors. I don’t think we’ve had a situation where investors have lost money,” said Mr Zhang. “I think it’s going to change the expectations for some investors for the potential credit risk, and have some risks for the rolling over of a lot of these trust products.”

The trust offered investors a 10 per cent yield, compared to the benchmark deposit rate of just 3 per cent. The first payment is not due until the end of this month.

Double digit returns risk free, right? Here we go again.

Would this shadowy activity be contained much as our central bankers assured us that our sub-prime issues would back in 2007?

This has raised increasing concern at government level, with the State Council warning earlier this month that shadow banking risks are “complex and hidden, and vulnerabilities can emerge suddenly and spread easily causing systemic problems”.

Analysts warn that the economic effects of a major problem in the Chinese shadow banking sector would not be confined to the People’s Republic.

Navigate accordingly.

Larry Doyle

Please order a copy of my book, In Bed with Wall Street: The Conspiracy Crippling Our Global Economy.

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The opinions expressed are my own. I am a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.

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