China “Shadow Loan” Fund Defaults: Start of Next Global Financial Crisis?

February 13th, 2014 by

bank

Western media has picked up the news that the Jilin Province Trust Co., which marketed high yield “shadow loan” investment products, has announced that it will default next week for the fifth time on a payout to investors. This fifth of a planned six payouts is worth 100 million yuan ($16.5 million). Local news sources report that Jilin has defaulted onĀ  all four previous payouts of the fund, totaling 764 million yuan ($126 million).

Jilin promised investors a 9.8% annual return, and marketed 1 billion yuan worth of shares through China Construction Bank, the nation’s second-largest bank. The money raised by the trust was then used to make a “shadow loan” to distressed local coal company Shanxi Liansheng Energy, which could not qualify for a bank loan. Jilin insists that it has not defaulted, only that the funds are not available from Liansheng at the present time.

Liansheng is “restructuring” and negotiating with creditors, but it has not filed for bankruptcy, making the claims of Jilin technically true. However, a local court has ruled that the coal company has not paid workers, pensions, or bills, and has lost the capability to service its debt.

Some analysts estimate the “off the books” shadow banking sector in China constitutes as much as 60% of total GDP. Worries are increasing over distressed companies defaulting on these loans. This could have a snowball effect, bringing about a “Chinese Lehman moment” that would plunge the world economy into another global financial crisis.

Another “investment product,” the “Trust Equals Gold” trust, was on the verge of default earlier this year, due to loans made to another coal company which went bankrupt. The fund was bought out by anonymous investors, which is widely assumed to be the Chinese central bank (because many wealthy and politically connected people were about to lose their money.)

China’s top financial regulator has warned about investing in these investment products that make non-bank loans to the coal and heavy industry sectors, citing over-capacity and falling revenues.

Western analysts chastised the Chinese government for bailing out Trust Equals Gold, as it implicitly signaled the market that any financial scheme, no matter how risky, would be rescued by the government (somewhat hypocritically, considering the U.S. bailout of Wall St. banks). The Peoples Bank of China has made noises hinting that such would not be the case.

The revelation about Jilin Trust has analysts speculating whether the impending financial disaster has Chinese citizens running for gold, which would explain their high demand for physical gold in the week after the Lunar New Year (a traditionally slow time for gold.)

With spot gold pushing over $1,300 today for a new 2014 high, and continuing robust Chinese demand, a gold run could be set off in an instant by shadow banking defaults in China setting off a liquidity crisis.

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