Ghostly skeletons of large residential estates, half-finished shopping malls, empty apartment buildings with no windows, serviced by dirt tracks full of potholes. Sound familiar?
These images of half-built luxury ghost developments are known to Irish readers, but they are relatively new in China, where the property market has slowed significantly since the government introduced cooling measures to stop the boom turning into a bubble.
In places like Ordos in Inner Mongolia, hundreds of projects have ground to a halt after a building boom fuelled by over-investment went bust, leaving tens of thousands of investors at risk of default.
In the search for options that offer more than the minimal return of a bank deposit book, investors in China have been piling into investment vehicles known as trusts, which promise high annual interest rates and a return of principal for people with more than a million yuan (€120,000) to invest.
According to Wang Tao, chief China analyst at UBS, trusts account for more than a quarter of the country’s estimated $3.35 trillion (€2.56 trillion) in non-bank lending, or about 45 per cent of China’s gross domestic product.
The investment bank Sanford C. Bernstein Co estimates that shadow finance in China totals about 20 trillion yuan (€2.45 trillion), or a third of the current size of the bank lending market.
Shadow banking in China includes banks’ off-balance-sheet vehicles, such as commercial bills and entrusted loans, as well as underground lending by individual. The reason it is booming in China is because more than 90 per cent of the nation’s 42 million small and medium-sized enterprises (SMEs) – find it difficult to get bank loans.
Liquidity risk
Xiao Gang, management board chairman of Bank of China, warned in a recent editorial in the China Daily how China’s shadow banking is contributing to a growing liquidity risk in the financial markets.
Trust companies were run in a manner that was “fundamentally a Ponzi scheme”, Xiao said. “China’s shadow banking system is complex, with a close yet opaque relationship to the regular banking system and the real economy. It must be tackled with care and sufficient flexibility, but it must be tackled nonetheless.” He added: “Regular banking and shadow banking are not isolated from each other. Many activities in the two systems feed into each other and could influence each other if things start to deteriorate.”
An Ordos developer spoke anonymously to The Irish Times. Mr Li, about 37, started out as coal mine operator before moving into land speculation and property development in 2004, quickly becoming one of the biggest developers in the region.
“It was a market with great prospects back then and land prices were cheap,” he said.
“I built offices and residences and, at the time, it was easy to get money from the bank and prices rose rapidly.”
His latest project is a large multi-function entertainment centre.
Construction has been completed but he has run out of liquidity to finish fitting out the interior while other aspects have stopped completely.
“The problem is, national policy changed and it was practically forbidden to lend money for property development any more,” said Li. “Before it was easy to get money from the banks, now it’s not possible at all.”
Like many others in his position, Li turned to the trust firms. There are 64 if them in China with sales offices in major cities. They combine characteristics of commercial and investment banking, private equity and wealth management.
They pool household savings to offer loans and invest in real estate, stocks, commodities, even bottles of sorghum liquor. No other financial firms operate across all these asset classes.
“Trusts make us nervous; their demands are too high,” Li said. If he is not able to pay back the investment in a year, the trust will take over big chunks of his property. Three years ago, the trust invested 300 million yuan (€37 million) and he paid it back in a year, but the pressure was intense.
Developers are now waiting to see what happens following the recent 8th Communist Party Congress.
“The central government will try to do more to improve people’s livelihoods and it’s possible that these ghost developments will be turned into low-rent housing or as places to settle people who have been moved out of their homes,” Li said.
“Our only hope is to rely on the local government, to see if there are any new policies, to see what they can do for us. Otherwise we have no other way out.”
Investment difficulties
One of the reasons for the rise of the shadow banking sector has been the fact that it is difficult for Chinese investors to find vehicles for their money
The ruling Communist Party has promised to promote freer movement of capital in and out of the country for investment purposes and to make the exchange rate more market-based. The government has also promised to keep an eye on shadow banking to make sure that it does not get out of hand.
