A "Lehman Moment" for China?

CHINA ADVISORY - Report 22 Sep 2023 by Andrew Collier

Shadow banking poses a systemic risk to the Chinese economy as part of a greater debt problem. In this report, we trace the development of shadow banking in China and discuss the areas where risks to the sector lie.

The main driving force behind the current demand for shadow credit has been the local governments. This is due to a structural deficit in local government revenue that was created by the tax reform of 1994. Facing dwindling revenue, the central government rammed through a proposal for Beijing to take the majority of tax revenue from the local governments with a promise to remit a portion back to the provinces. However, this promise was never fulfilled, forcing the provincial and sub-provincial governments to find new sources of revenue. The property and land boom, fueled by shadow banking credit, was the tool to replace inadequate tax revenue. Property became the engine that filled government coffers, delivered economic growth, and provided an asset class to build wealth—temporarily.

China is unlikely to undergo a “Lehman Moment” due to the state ownership of the banking system and loose control of shadow banks. However, the unwinding of debt in the shadow banking sector will increase the deceleration of China’s economic growth.

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