China Banking Crisis

China is going through a series of crises and it’s not one not two but three crises occurring together which are the realistic crisis the banking crisis and now the credit crisis five banks have already crashed SMES that contributed around 60 percent of the Chinese GDP are struggling for cash and the Chinese economy hit a bigger growth rate of just 2.99 in 2022 and all of this is because of the government of China made one critical mistake that has a ton of lesson that India needs to learn from the question is in spite of such an incredible rise why is China slowing down now what was the governance mistake that snowballed China into both a real estate and banking crisis and most importantly as citizens of India what are the lessons that India needs to learn from this China banking crisis.

Start Of China Banking Crisis

This is a story that dates back to 2008 now three things happened in China number one China went from being a poor country to the second largest economy in the world because it became the factory of the world number two foreign direct investment went from zero to 110 billion dollars from 1970 to 2008 and most importantly 800 million people had been lifted out of poverty but this is when 2008 crisis happened. now when the 2008 crisis hit the Western countries it badly hurt the Chinese economy because Why because China was the world’s Factory but when the companies faced the cash Crunch and demand collapsed these companies literally did not have much to manufacture so if you are a t-shirts company that already has stock in your inventory and nobody’s buying that you will not ask your Chinese vendor to manufacture more t-shirts right this is the reason why foreign direct investment in China started slowing down and if you look at the 2008 effect on China you will notice that foreign direct investment growth in China went from plus 29 to -13.2 percent in 2009. So the ripple effect effect of the 2008 crisis had badly affected the China growth and this when the Chinese authorities realized that they cannot be so dependent on other countries for China’s growth so they wanted to do something quick and effective to keep their economic growth only on the upward trend so you know what the Chinese authorities came up with a strategy to aritifically inflate the Chinese economy yes you heard that right they tried to artifically inflate the Chinese economy the question is how the government of China set aside 4 trillion Yuan for this move which is about 586 billion dollars and they asked the banks to give out loans to businesses and state owned companies but in spite of that there were three major problems that popped up in the Chinese market the first problems was that target deficit problem faced by the local Chinese government in simple worlds let’s say the local government has a Target to achieve 1 000 crores in economic growth which iwll require at least 500 crores of investment in 2022 but the problem is that the amount of money that the local government has is only 200 crores and 100 crores have come from the center now they need another 200 crores to be invested to achieve the strict targets of the government now in usual cases what would the local government in India do they would take out a debt of 200 crores and fullfill the targets right but imagine if the leaders of the country have imposed to regulation such that you cannot borrow beyond 50 crores from the banks but you still have to meet your targets so do you realize the problem over here there is a target but they are facing a deficit of 150 crores for which they cannot take loans the second problems was that even though the banks were asked to give out loans even though there was a lot of demand for these loans the banks had to cap their fixed deposite interest at 2.3 per cent and the lending rates at 5.31 per cent at the same time they had a ton of restrictions that prevented them from giving out loans beyond a certain level so if you are a businessman even though your credit history is great you cannot borrow beyond a certain cap and even though your documents are all intact your loan processing would take a lot of time so you see this is a lose lose situation Banks want to make a profit by giving out loans at higher interest rates but they cannot due to the government restrictions the local government has a target to achieve but it is not able to borrow enough money to achieve those targets and lastly the people of China want loans for their businesses but they are not getting it because of the government restrictions and this is what created the third problem in the Chinese market which was a result of shadow banking.

For those who don’t know Shadow banking is a system consisting of leaders and brokers who fall outside the realm of the traditional regulated baking so Shadow baking is generally unregulated banking and it is not subject to the same kinds of risk liquidity and capital restriction as traditional banks basically they are unregulated as compared to traditional banks so because the Chinese banks were so slow and so picky about their loans all this demand went into the shadow banking industry such that people were willing to take a loan even at 18 per cent interest and it’s not just the private entities but even the banks started private lending for examples let’s say a bank has 50 crores of cash to be lent and you as a businessman need 50 crores for your working capital in the organised market the banks will have to do all the sue diligance and give you the loan at 5.8 per cent interest but it will do it in a very restrictive and slow manners but with private lending the bank would immediately give a loan of crores and keep it off their balance sheet eventually they will charge you an interest of 18 percent on it this way you get the laons the banks get profit and the government’s ego gets pampered this is the simple functioning of the shadow banking in china so tomorrow if you default the banks does not have to show it in the balance sheet and hence it could escape the government and just like this not just businessman even the local government started borrowing from banks privately at interest as high as 18 per cent why because they were forced to meet their targets so do you see what is the problem over here now even the banking system is functioning exactly the same way the banks are still giving out loans the businessman are still taking these loans and even the local government are taking out these loans in order to increase the GDP it is just that earlier this was happening on paper but later on it was happening off paper and that too merely due to bad governance if you see this chart shadow bankign which is represented in orange picked up very very quickly after 2008 to touch very high level in 2016 to almost 25 trillion yuans and this is when the government of Chian realize that they had meesed up and the shadow banking industry had gone beyond control so you know what they came up something called the D levereging strategy in 2016,

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