Will China be the next to face a financial crisis?

Chinese flagDoubts are rising that China could be the next to face a financial crisis prompted by the growth of its shadow banking sector and local government debts.

In a report by JP Morgan Chase Bank in Hong Kong, Haibin Zhu, Grace Ng and Lu Jiang estimate that the shadow banking sector nearly doubled in size between 2010 and 2012 to 36 trillion renminbi (€4.4 trillion) or 69% of GDP.

Trust and wealth management products, they say, are the most important risk factors.

Aaron Kwon, chief executive and founder of Summit International Capital, agrees the country faces “formidable” challenges. However, he argues the Chinese leadership has the political power, policy skills and financial capacity to navigate it safely.

“China’s leadership enjoys political power unrivaled by its Western peers and offers China an important advantage in reforming the financial system,” he says.

Not only is China sitting on $3.34 trillion (€2.52 trillion) of foreign reserves, says Kwon, but it has demonstrated a “whatever it takes” approach to dealing with the financial crisis in 2008 and events such as the Tiananmen Square protest three decades ago.

In the worst possible scenario, says Kwon, the Chinese leaders will deploy the “financial backstop” and use policy actions to unfreeze the system.

The trio at JP Morgan Chase Bank, however, is more concerned. The potential risks related to shadow banking include default risk, liquidity risk, legal risk and regulatory risk.

“Shadow banking will likely continue to grow, but at a slower pace,” says the report, which concludes that Chinese regulators will selectively tighten regulation while broadly supporting the sector.

©2013 funds europe