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Bank of England's Mark Carney sees shadow banking in emerging markets as biggest global risk
Mark Carney sees threat to global financial stability from huge amount of assets in informal banking sector in China
Mark Carney said the world is still suffering the effects of the credit bubble five years after the collapse of Lehman Brothers Photo: Paul Grover
By Ambrose Evans-Pritchard
4:48PM GMT 13 Dec 2013
13 Comments
Bank of England Governor Mark Carney has warned that the global financial crisis is rotating from West to East, with shadow banking excesses in emerging markets now posing the biggest threat to the international economy.
Mr Carney said the world is still suffering the effects of the credit bubble five years after the collapse of Lehman Brothers but the epicentre of stress has shifted. "The last financial crisis in the advanced countries is finished. The greatest risk is the parallel banking sector in the big developing countries," he said.
"That is why it is necessary to push through reforms not only in the advanced countries, but also in the emerging countries at the same time," he said, speaking in French after a meeting at the French Treasury in Paris.
The warning comes as jitters over bond tapering by the US Federal Reserve lead to fresh strains in the currencies and bonds of the most vulnerable emerging market states, led by sell-offs in India.
Mr Carney did not name any particular country but analysts said he was clearly referring to China, where a surge in off-books banking over the past year has accounted for roughly half of all credit growth.
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"He means China because that is where the real problem is. There is no large fringe banking system in India, for example," said Charles Dumas from Lombard Street Research.
Fitch Ratings says the explosive growth of loans over the past five years in China is unprecedented in any major country in recorded history. Credit has risen from 125pc to 200pc of GDP, if all forms of trust funds, wealth management products and offshore banking are included. The Chinese credit system has grown to $24 trillion from $9 trillion in late 2008, equivalent to adding the entire US commercial banking system.
The pace of credit growth over the five-year period exceeds the extremes seen before Japan's Nikkei bubble burst in 1990, or before the onset of the US housing crash in 2007.
China's banking system is ultimately controlled by the state. Any post-bubble credit purge is likely to play out in a different way, with less risk of a dramatic crisis and more risk of a chronic malaise.
China’s central bank seems determined to rein in rampant growth of the M2 money supply and to cool the credit boom before it reaches unmanageable extremes. It has already tightened monetary policy, raising interest rates by 75 basis points this year. This has pushed Chinese bond yields to the highest in a decade and is leading to serious stress in parts of the credit system.
Bank of America has advised clients to take out default insurance against Chinese debt, warning that markets are too "complacent" about the likely fallout from monetary squeeze.
Bin Yao, the bank’s credit strategist, recommends buying credit default swaps (CDS) on five-year Chinese debt as the easiest way to “hedge the China tail risk”. These contracts spiked to 266 after the Lehman crisis and again to 206 during the "hard-landing scare" of late 2011. They have been trading this week at just 66.
Bin Yao said parts of the shadow banking system are highly vulnerable. “We find trust loans especially troubling,” he said. Short-term debt issuance by trust companies has jumped to $320bn from almost zero two years ago.
A new study by the China Academy of Financial Research warned that the trusts face a redemption shock after promising returns of 10pc to 15pc that may be impossible to deliver.
The pattern has echoes of what happened to Icelandic banks and Northern Rock, which relied on fickle capital markets during the credit boom. They were caught in a vise when funding suddenly dried up. The Academy said Jilin Trust, AsAc and Taipingyang Municipal are among the most over-extended. All three have had trouble rolling over debt or covering payouts over recent days.
China’s central bank is walking a tightrope, trying to cool the market under its “flexible opaque” policy without causing an economic crisis. It has targeted M2 growth of 13pc, which implies further tightening. It has pushed real interest rates up to a range of 1pc to 2pc, an unpleasant surprise for those relying on negative rates to fund high leverage.
Investors do not usually buy CDS insurance because they think a country will default. The contracts are used as a hedge by companies with heavy exposure to an economy, often in fixed plant or other illiquid assets. The CDS market acts as a stabilising force, reducing the risk of asset fire-sales in a crisis.
The contracts are also used by traders as a proxy for betting on political and financial stress. Volatile spikes can yield turbo-charged gains for those who time it right.
Mark Carney sees threat to global financial stability from huge amount of assets in informal banking sector in China
Mark Carney said the world is still suffering the effects of the credit bubble five years after the collapse of Lehman Brothers Photo: Paul Grover By Ambrose Evans-Pritchard
4:48PM GMT 13 Dec 2013
13 Comments Bank of England Governor Mark Carney has warned that the global financial crisis is rotating from West to East, with shadow banking excesses in emerging markets now posing the biggest threat to the international economy.
Mr Carney said the world is still suffering the effects of the credit bubble five years after the collapse of Lehman Brothers but the epicentre of stress has shifted. "The last financial crisis in the advanced countries is finished. The greatest risk is the parallel banking sector in the big developing countries," he said.
"That is why it is necessary to push through reforms not only in the advanced countries, but also in the emerging countries at the same time," he said, speaking in French after a meeting at the French Treasury in Paris.
The warning comes as jitters over bond tapering by the US Federal Reserve lead to fresh strains in the currencies and bonds of the most vulnerable emerging market states, led by sell-offs in India.
Mr Carney did not name any particular country but analysts said he was clearly referring to China, where a surge in off-books banking over the past year has accounted for roughly half of all credit growth.
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"He means China because that is where the real problem is. There is no large fringe banking system in India, for example," said Charles Dumas from Lombard Street Research.
Fitch Ratings says the explosive growth of loans over the past five years in China is unprecedented in any major country in recorded history. Credit has risen from 125pc to 200pc of GDP, if all forms of trust funds, wealth management products and offshore banking are included. The Chinese credit system has grown to $24 trillion from $9 trillion in late 2008, equivalent to adding the entire US commercial banking system.
The pace of credit growth over the five-year period exceeds the extremes seen before Japan's Nikkei bubble burst in 1990, or before the onset of the US housing crash in 2007.
China's banking system is ultimately controlled by the state. Any post-bubble credit purge is likely to play out in a different way, with less risk of a dramatic crisis and more risk of a chronic malaise.
China’s central bank seems determined to rein in rampant growth of the M2 money supply and to cool the credit boom before it reaches unmanageable extremes. It has already tightened monetary policy, raising interest rates by 75 basis points this year. This has pushed Chinese bond yields to the highest in a decade and is leading to serious stress in parts of the credit system.
Bank of America has advised clients to take out default insurance against Chinese debt, warning that markets are too "complacent" about the likely fallout from monetary squeeze.
Bin Yao, the bank’s credit strategist, recommends buying credit default swaps (CDS) on five-year Chinese debt as the easiest way to “hedge the China tail risk”. These contracts spiked to 266 after the Lehman crisis and again to 206 during the "hard-landing scare" of late 2011. They have been trading this week at just 66.
Bin Yao said parts of the shadow banking system are highly vulnerable. “We find trust loans especially troubling,” he said. Short-term debt issuance by trust companies has jumped to $320bn from almost zero two years ago.
A new study by the China Academy of Financial Research warned that the trusts face a redemption shock after promising returns of 10pc to 15pc that may be impossible to deliver.
The pattern has echoes of what happened to Icelandic banks and Northern Rock, which relied on fickle capital markets during the credit boom. They were caught in a vise when funding suddenly dried up. The Academy said Jilin Trust, AsAc and Taipingyang Municipal are among the most over-extended. All three have had trouble rolling over debt or covering payouts over recent days.
China’s central bank is walking a tightrope, trying to cool the market under its “flexible opaque” policy without causing an economic crisis. It has targeted M2 growth of 13pc, which implies further tightening. It has pushed real interest rates up to a range of 1pc to 2pc, an unpleasant surprise for those relying on negative rates to fund high leverage.
Investors do not usually buy CDS insurance because they think a country will default. The contracts are used as a hedge by companies with heavy exposure to an economy, often in fixed plant or other illiquid assets. The CDS market acts as a stabilising force, reducing the risk of asset fire-sales in a crisis.
The contracts are also used by traders as a proxy for betting on political and financial stress. Volatile spikes can yield turbo-charged gains for those who time it right.
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