By Anjan Roy
China’s is staring in the face of a possible financial sector crisis, with its largest privately owned non-banking financial company unable to meet its obligations. Zhongzhi financial company, having widespread exposure to China’s real estate sector, has failed to honour its obligations to its investors and defaulted.
As such, the bankruptcy of a company in a country is of little interest to the outside world. It might just as well go down into liquidation. But everything to do with China is problematic for the global economy because of its sheer size. In China the numbers are too big, like often in America.
Zhongzhi as the largest privately held non-banking company has its tentacles spread through China’s non-banking financial industry. Its collapse will spread tremors throughout China and then could spread across. Hence, the world is watching the fate of Zhongzhi financial conglomerate.
Following reports of the default and protests from its investors and clients, the Chinese government has launched a “criminal” probe into the activities of the conglomerate. It has preliminary reports about serious irregularities in its investment and loan operations.
The group is otherwise an important player in China’s amorphous non-baking financial companies network. In China these are considered part of its huge “shadow banking industry” which is as large as an estimated $3 trillion. Of these, Zhongzhi is an important part.
Zhongzhi controls no less than some fifteen investment and wealth management firms. These are into consumer financing to real estate funding. One group company alone controls investments running into $85 billion, concentrated mainly into real estate operations.
China’s real estate sector is a principal driver of the economy now. With large scale infrastructure investments already made, there was little scope for making bit time investments into infrastructure. There is thus some emphasis on real estate and housing sectors.
In these sectors as well, sustained investments over the last three decades have built up massive excess capacity. Large townships created on virgin lands lie unoccupied as these have not been sold to the final takers. Even when these homes have been purchased, these have not been occupied.
Hence, the housing stock is remaining unsold, clogging up the finances of the housing companies. Already, several of the largest housing and real estate companies are facing liquidation, including the largest of them all, Country Garden real estate. The government is keen to help these beleaguered housing and real estate companies.
Xi Jinping himself has taken initiative to now bail them out, contrary to the earlier stance of letting them face the situation. Because of real estate and housing is so important in the overall macro-economy, the government had to reverse its stance and float ambitious rescue plans. These are being initiated, but already the insolvency of the real estate sector has left a trail of damages along the way.
One of these collateral damages has been the shadow banking industry. While Zhongzhi’s woes are primarily related to souring of its large portfolio of investments in real estate and housing companies, there are reportedly some serious irregularities reported as well. The Beijing Police is looking into it.
In a way, when firms get into a troubled spot stemming from overall macro situation, they most often try to wriggle out via some short cuts. These are often caught on the wrong side of laws. The initial reports indicate that since 2021, the companies have strayed into these subterranean worlds.
When macro-economy turns sour, the non-banking sector gets into knots. The case of Zhongzhi immediately reminds the Indian observer of what had happened in the largest Indian non-banking company, ILFS Ltd, couple of years back. ILFS had funded many of India’s private sector infrastructure companies.
While the projects were sound, they were a financial deadweight around the neck. The problem of funding long-term infrastructure assets is the mismatch between assets maturity and liquidity. Often enough, the maturity is long drawn out while these have been funded with short-duration funds. Hence, the repayments comes on hand, there is a funds crunch for the provider of loans.
Fortunately, the crisis within ILFS came out in the open fast enough and corrective measures were initiated. ILFS overcame its crisis and now appears to be back in the black.
What is important for maintaining the overall financial stability is monitoring and initiating early action. The financial sector is prone to periodical turmoil as operators tend to gather moss in times of growth. A culture and atmosphere of complacency creeps in and watch over the details flag. In this context, one must watch out for the moves of the Indian banking regulator.
Only in the course of its last monetary policy statement on October 6, the Reserve Bank governor, Shaktikanta Das, had mentioned of some untoward developments in Indian non-banking financial sector.
He said ‘The financial indicators of non-banking financial companies are also in line with that of the banking system as per the latest available data for June 2023. Certain components of personal loans are, however, recording very high growth. These are being closely monitored by the Reserve Bank for any signs of incipient stress. Banks and NBFCs would be well advised to strengthen their internal surveillance mechanisms, address the build-up of risks, if any, and institute suitable safeguards in their own interest.’
Following up the governor’s observations, Reserve Bank introduced new norms for risk recognition for consumer loans of non-banking entities as well commercial bank loans to the NBFCs.
RBI had raised the risk weightage of consumer credit of commercial banks as well as non-banking financial companies have been raised by 25% from 100% to 125%. Risk weightage of commercial bank loans to NBFCs were similarly hiked and credit card receivables risk weightage was further increased.
These would surely restrict flow of funds for consumer credit and thus affect the level of consumer demand for various consumer durables from cars to fridges or washing machines. In the current phase of incipient growth of demand after the decrease in the activity levels in the wake pandemic, the overall consumer demand might be affected.
However, some caution in the more comfortable phase of growth is handy to avoid a possible crisis in the next phase of some correction. One has to admit the strong hand of the regulator and constant monitoring are reassuring for the health of the overall economy. (IPA Service)