China’s risky shadow banks back in spotlight after debt crackdown

China’s crackdown on borrowing by local governments is forcing state-run entities in even some of the wealthiest provinces to tap costly credit from non-bank lenders, a stopgap that is increasing risk in an opaque corner of the financial system.

The borrowing marks a return of China’s shadow-banking market, which is more loosely regulated than traditional lenders and had been reined in over the past few years in a bid to reduce risk. Since September, industrial investment arms and financing platforms owned by local governments in provinces including Shandong had borrowed billions of dollars in total from trust companies and leasing firms, according to people familiar with the matter.

The rates charged were 8 per cent or higher – more than triple the cost of borrowing in the bond market, the people said, asking not to be identified discussing private information. Financial institutions that make up China’s shadow banking system are willing to extend the funding partly because they’re short of assets in a low-rate environment.

The increased demand reflects the fallout from Beijing’s campaign to keep provinces from amassing debt through state-owned companies known as local government financing vehicles, or LGFVs. The effort has choked off their access to cheaper funding such as regular bank lending and bond sales, contributing to a pullback of investment in the world’s second-biggest economy.

“Platforms in rich regions wouldn’t have to resort to such expensive funding should fiscal discipline be less strict,” said Jacqueline Rong, chief China economist at BNP Paribas SA. “The campaign to resolve hidden debt and the fiscal discipline might be a key reason for the deep slump in infrastructure investment.”

China’s Ministry of Finance, the National Financial Regulatory Administration and Shandong’s government press service did not respond to requests for comment.

As interest payments piled up, and with expenses of settling the cost of projects coming due in the fourth quarter, the firms had little choice but to refinance at higher rates to keep their businesses running and avert default, said the people.