Factors leading to this happened

• Insufficient supply of credit from four major banks (during the high-speed China’s economic development era)
• Limited regulations over risky loans
• Limited regulations over arbitrage
• Inter-bank interactions exclusion from credit management
• Chinese government’s control over interest rates
• Criteria of promotion for the local government leaders
• Others
  • Regulatory discouragement of lending money to certain industries 

Additional risks

About two-thirds of all lending in China by shadow banks are “bank loans in disguise”.^[7] One of the controversies of this industry is that retail investors are largely unsure about what sorts of risks they are taking on when engaging in shadow banking.^[8] The connections between traditional banks and the shadow banking system further cloud the picture and at the same time contribute to increased risk.^[9]

Methods in detailed

• Wealth Management Products(WMPs), aka. 理财产品
  • Why people would invest it? And what’re its risks?
    • Compared to deposit, it can offer higher return.
    • Although people invest, they usually don’t know what exact portfolio would financial institutions invest, as well as banks usually wouldn’t like to tell them. Moreover, some of products cannot even ensure investors’ principles, which put huge risks on investors. 
  • How can it bypass regulations? Or, how can this shadow banking activities do not appear on banks’ balance sheet?
    • Their yield comes from the ‘performance’ or ‘value’ of assets upon which the product is built. These financial products designed and sold by financial institutions, like banks, trusts and securities firms, do not appear on the institutions’ balance sheet.
    • Ostensibly, banks act like an intermediaries rather than actual holders, which gives them reasonable pretexts that they don’t show this shadow banking activities on balance sheet.
  • How’s the situation in US? And why doesn’t Chinese government legislate it to force it to appear on the banks’ balance sheets?
    • Issuing a WMP is strictly regulated in US, through several regulatory bodies, while, although such products do have some regulation to some extent in the PRC historically, they’re loosely regulated, which makes evasion from regulation possible and rampant. For now, the central government has made more significant efforts to regulate WMPs and shadow banking.
    • Although Chinese government, including its highest leaders, is aware of this situation, even the central government does not know the exact amount of number of WMPs. Secondly, considering the officials’ criteria of promotion within the CCP system, historically, local government would try their best to maximize leveraging, and the central government also knows this, but considering the fast development needs and how the authoritarianism system works, both local and central government historically didn’t have such willingness to regulate it.
    • As for now, the amount of number is enormously large, which is really a big problem and several serious results have risen up. Recognition of central government about this serious issue makes central government to have strong willingness to regulate, but, as for the local government, the criteria of promotion remains similar. The easier ways to achieve the economic development, aka GDP numbers in CCP’s criteria system, is still to leverage, resulting in local governments to have less willingness to regulate this. Although considering the pyramid system within the CCP, sometimes local governments have to follow the instructions from higher leadership, while, it’s still clear to say the local governments don’t  have such stimulus to regulate. If such situation were not to be changed, we will still see huge investment from the local government, such as infrastructure investment.
    • Hypothetically, If the central government were to force banks to include the WMPs on their balance sheets immediately, several negative and serious economic results would occur, such as bank runs, bankruptcies, economic instability. This creates a dilemma: forcing banks to include them on balance sheet would cause problems, while, maintaining the status quo would also lead to problems eventually.
  • The number of WMPs
    • Its number has been increasing steadily, with it increasing from less than ¥500 billion in 2004 to ¥9.5 trillion by the end of 2013. 
• Trust Products
• Entrusted Loans
• Alternative Financing
• Interbank Market Activities
• LGFVs
• P2P
• ……

Reference

Shadow banking in China

How China Works: An Introduction to China’s State-led Economic Development

Prelude

Without understanding of China’s politics, then it’s impossible to understand China’s economy. Starting from the last year of the ominous China’s economy, I also got much more interested in macroeconomics, or, I got interested in for the first time in my life. Of course, I think English helps a lot in terms of cultivating my interest, which I don’t have to read about written in a monotonous CCP’s language.

This is a book showing several important periods of transition and development, terminologies of the Party and the economics, historical background and factors, logics of how it develops and works, etc. Although the PRC’s economics and politics are closely associated, this book focuses more on economic sides. So, whether your political spectrum is more pro-CCP, neutral, or pro-democracy, this book is beneficial for everyone who wants to know and understand China’s economy about where should and would it go. In fact, if you take closer to think about its publication date and the contents written in the book, you can see the author even “predicted” the future to some degree, which requires you to know clearly about the current situation.

It also takes time to read, considering its terminologies, background and complexity. If I could borrow a word from Mandarin to describe its category, I would use “通识”, stands for liberal education in English. If there’s no other book surprises me this year, I think this will be my “The Book in 2024”. Anyway, hope you enjoy it.

Excerpt

The following is extracted from the book that I think they’re interesting, combined with some other materials I researched.

条块关系& 四套班子

The departments’ relationship can be called “vertical strips and horizontal blocks” relationships, namely, “条块关系”, in the China’s unique political structures consisted by the “four teams”, namely, “四套班子” : party committees, administrative government, the National People’s Congress and the Chinese People’s Political Consultative Conference.

The “four teams” structure is replicated at each level of the government, with a few notable exceptions. For example, the central government has the Ministry of Finance, the provincial government likewise has a finance department and the city and county government has a finance bureau.

Most local government departments have to accept dual leadership from both stripes and blocks. As an example, a county-level education bureau needs to accept the leadership of both the city education bureau vertically and the leadership of the county-level party committee and county government horizontally. In this example, the “strip” means the higher department and the block means the party committee and the government in the same level.

属地管理 & Externality

The geographical scope and authority of China’s local government is determined by administrative districts, and the extent of local power is bound together with the administrative district in question (属地管理).

Division of Administrative Districts

Factors: Languages, population

Areas of population inflow can merge counties and establish districts to expand the city, however areas of population outflow rarely abolish administrative districts, preferring instead to merge facilities to save cost (e.g., merging two schools together).

Regions located at the boundary of administrative districts tend to be underdeveloped. This phenomena, known as “三不管地带” roughly translated as “anarchic regions”, can also be explained using the framework of scale effects and boundaries of public goods. Interestingly, such problems are also existed in the ROC era, moreover, these anarchic regions provided a fertile space for the Communist party during the revolutionary period(1921-1949). Such phenomenons were demonstrate on roads a few decades, but this is limited to roads and expressways invested by the provincial government, not national roads and railways. Now, traffic is not a major problem. Some provinces choose to locate factories and businesses that have a high level of water pollution on downstream provincial borders, in doing so the pollution released mainly affects the downstream province and the average level of pollution in the polluting province may actually decrease.

To solve the anarchic regions problem, the best way to manage the cross-district externalities is to appoint a supervisor with authority to coordinate and make decisions. This is why strips and blocks systems are needed.

文山会海

According to the most recent regulations on the handling of government and party documents issued by the State Council in 2012 (which I will refer to here as “the regulations”), there are 15 types of official document. These include “Decisions” and “Orders” which must be strictly implemented by lower levels, those that can be handled relatively flexibly, such as “Opinions” and “Notices”, as well as those which have less information content such as “Letters” and “Minutes”.

七通一平

Before the firm moves in, the local government will make some initial investments in the area, including providing electricity, transport links, heating, ventilation, supplying water, drainage and communication networks, and the land must be leveled as well. (a process known in Chinese as “七通一平” which translates to “7 openings and 1 leveling”).

三免三减半

Local governments can also provide tax incentives or subsidies for certain businesses. Examples may include tax credit for research and development or subsidies on export. One common tax incentive involves businesses paying no corporate income tax for the first three years of operation and paying half the rate for years 3 to 6 (known as the “three tax-free and three half-tax” or “三免三减半”).

The reasons why land finance became such prominent, namely, the surging price of houses

However, in 1998, two significant changes occurred, and the true value of urban land began to emerge. The first change is that government and state-owned enterprises (SOEs) stopped building housing for their workers, and instead paid money to the workers in the form of a housing subsidy. The era of commercial housing and real estate development therefore started in earnest. From 1997 to 2002, the average annual growth rate of newly constructed residential areas reached 26%, and the absolute number increased 4x in 5 years. The second change is that the implementation of the revised “Land Administration Law of the People’s Republic of China” which stipulated that rural land could only be used for non-agricultural construction purposes if it is first transferred to state-owned land, thereby giving city governments a monopoly over urban land construction.

Land Finance & Debt & Snowball

The real power of “land finance” is not the high sales value of land use rights, but its ability to use land as collateral to mobilize capital markets and leverage up more funds for investment. It snowballs in size, leading to more and more investment, but also more and more debt for local governments, which has become a significant problem for China’s economy in recent years.

LGFVs(Local Government Financing Vehicles)

aka. 地方政府融资平台

However, the official name of these vehicles does not contain the word “financing”, rather most of them use words such as “investment and development” or “construction”, which emphasizes the company’s role in investment rather than financing. So in China, these vehicles are also collectively referred to as Urban Investment Corporations (城投公司).

To use some Chinese terminology, a piece of “raw land” (生地) that has been marked for development, can turn into “ripe land” (熟地) ready for development, only after the land is leveled and cleaned up.

Government industrial Guidance Funds / Private Equity Funds

Local governments cannot borrow directly from banks, therefore urban investment corporations act as financing vehicles. Similarly, governments cannot make direct equity investments in capital markets, therefore it is necessary to set up a company to operate and manage the guidance fund.

These fund managing companies fall into 3 broad categories. The first group are wholly state-owned enterprises, such as Beijing Yizhuang State Investment, an investor in BOE. The second group are mixed-ownership companies, such as Shenzhen Capital Group Co. Ltd., which is entrusted to manage the huge Shenzhen Guidance Fund. The largest shareholder of this company is the Shenzhen city government, but it only holds a 28% share. The third category is more like CFLD discussed in the previous chapter. Guidance funds in small cities are small in scale, and local governments have neither the resources nor the expertise to establish special management companies for them, so they simply entrust the funds to private companies, such as Prosperity Investment Group.

Shadow Banking 影子银行

The bank may therefore create a so-called wealth management product that attracts household savings at a rate of 5%, entrusting the money to a trust company. Then the trust company lends the money to the real estate company. In this so-called bank-trust cooperation, the wealth management product created by the bank is not recorded as bank deposits, and the money entrusted to the trust company is not recorded as bank loans, so the entire transaction is not recorded in the balance sheet of the bank and is therefore not subject to bank regulations. This is a form of shadow banking.

Branches of Economics

• Divided by Scale
  • Macroeconomics
    • Branch of economics dealing with the performance, structure, behavior, and decision-making of an economy as a whole, rather than individual markets.
  • Mesoeconomics / Mezzoeconomics
    • In-between macroeconomics and microeconomics with a focus on the intermediate level of analysis.
  • Microeconomics
    • Branch of economics that studies the behavior of individuals and firms in making decisions regarding the allocation of limited resources
• Divided by Types
  • Classical Economics
  • Behavioral Economics

Monetary Policy 货币政策

Unconventional Monetary Policy at the Zero Bound includes credit easing, quantitative easing, forward guidance, and signaling.

• QE, Quantitative Easing 量化宽松
• Credit Easing
  • Credit Easing and QE are similar, but have some difference.
• Helicopter Money,
  • Can sometimes be perceived as an alternative QE, when the economy is in a liquidity trap (when interest rates near zero and the economy remains in recession).
• QT, Quantitative Tightening, 量化紧缩
• Tapering (in economics), reduction of the quantitative easing program in the US
• Short-Term Interest Rate,
• OMOs, Open Market Operations, 公开市场操作
• Forward Guidance, 
• Credit Guidance (Broader), Window Guidance (interchangeable with the Informal Guidance)
  • Nuances between these three terminologies (to be posted)
• Reserve Requirements, 
• Exchange Requirements, 
• Collateral Policy, 
• Signalling, 

Types of Interest Rate

• Prime Rate, or Prime Lending Rate
  • LPR, Loan Prime Rate, 最优惠贷款汇率
    • Used exclusively in the mainland China, moreover, both Hong Kong and Macau do NOT use LPR, it is ONLY existed in the mainland China, in the terms of the world. Before LPR was introduced on Aug. 17, 2013, the mainland China used BLR, Benchmark Loan Rate, instead.
    • BTW, Laryngopharyngeal reflux is also LPR, or laryngopharyngeal reflux disease, LPRD
• Federal Funds Rate
  • Used in U.S.
• Repo Rate, 
• IBOR, Interbank Offered Rate
  • Libor, London Inter-Bank Offered Rate
• Bank Rate, aka. Discount Rate(in AmE), 
• Mortgage Rates
• APR, Annual Percentage Rate,
  • eAPR, effective APR
• AER, Annual Equivalent Rate, aka. the effective annual rate,
• Annualized Interest Rate

Fiscal Policy 财政政策

Notice the difference between fiscal policy and monetary policy.

Stock & Market & Financial Products

IPO, Initial Public Offerings, 首次公开募股

Financial Market 

• Primary Market, 一级市场, aka. 发行市场, 初级市场
• Secondary Market, aftermarket, follow on public offering, 二级市场, aka. 次级市场

Types of Financial Products  

• In broad terms 
  • stocks(股票), bonds(债券), options(期权), futures(期货), forwards, shares(股份), funds(基金), deposit(存款), trusts(信托), equity(股权), annuities(年金), insurance(保险), Derivatives(衍生品), 
  • Difference between forwards and futures
• More specific products
  • Snowball Products, hedge funds, 

Incompletely, there’re some financial products can be seen as zero-sum games, including futures, forwards.

Invest Strategy

• Global Asset Allocation 
• Portfolio

Indicator

Market & Business

• CPI, Consumer Price Index
• PPI, Producer Price Index 
• CCI, Consumer Confidence Index
• PMI, Purchasing Managers’ Index

Stocks

• S&P 500, Standard & Poor’s 500
• NASDAQ Composite

Government

• Nominal Anchors

Economic Situation

• Liquidity Trap
• Stagflation
• Hyperinflation
• Deflation
• Middle Income Trap
• Recession
• Fiscal Cliff
• Credit Crunch
• Balance of Payment Crisis
• Boom and Bust Cycle
• Structural Unemployment 

Apparatus / Organization

PRC

PBC(officially used by PRC) / PBOC(informal) / People’s Bank of China, 中国人民银行, 人民银行, 央行, 中国中央银行

CBRC, China Banking Regulatory Commission, 中国银行业监督管理委员会, 中国银监会, authorized by the State Council, except the territories of Hong Kong and Macau

• Bank
  • ICBC, the Industrial and Commercial Bank of China,
  • BOC, the Bank of China
  • ABC, the Agriculture Bank of China
  • CCB, China Construction Bank

U.S.

The Federal Reserve System / the Federal Reserve / the Fed (simplified),  美联储

Clearinghouse,