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Joe Zhang's speech at the Foreign Correspondents' Club in Hong Kong on 26 June 2013
Thank you for having me here today. In the past two years, I have run a microcredit firm in Guangzhou, having invested in a couple of other similar companies. In April, I had a burning desire to write a book about shadow banking in China. In May, the book came out entitled "Inside China's Shadow Banking: The Next Subprime Crisis?". Soon, my former colleagues at the central bank in Beijing started to promote my book, albeit by accident. As a result, the book is selling very well.
Thank you very much.
What do you make of the saga last week in the Chinese interbank market? The media say there was a cash crunch on the part of the central bank. Really? I must say I find this hard to believe. With broad money supply growing at about 16% every month (on a very high base), is there a cash crunch? China has one of the most inflationary monetary policies in the world, much more so than QE2 or QE3 in the United States or Japan.
Forget about the technical nuts-and-bolts of the interbank market; what I see in China is a banking sector that has expanded credit much too quickly, and some banks have been caught in a maturity mismatch. Unlike the past two decades, the central bank suddenly became less willing to accommodate those who use the interbank as a staple funding source, and those who use the central bank as the lender of first resort, rather than the lender of last resort.
This morning, my sister in central Hubei Province called me to ask if she should roll over a wealth management product as interest rates had suddenly jumped to more than 5% from 4%. I myself also got a text message from my client adviser at Merchants Bank telling me that there was a superb deal available. The scare last week has clearly had a ripple effect. Both my sister and I regularly buy wealth management products, and I tell you that I do not have the slightest concern about their asset quality. I argue in my book that their quality is either at par or better than bank deposits.
Looking at China's 6000+ microcredit firms, thousands of pawnshops, and particularly thousands of curb-side lenders (many of which are huge in size), I find that their asset quality is terrific. Why? We are very nimble compared to banks, and we get to cherry-pick our customers. Second, we are using our own hard-earned money, and thus we are careful. Finally, the current operators are mostly survivors of "jungle justice," and they care little about academic elegance and are street smart.
What about banks' wealth management products? Hey, they are no different from bank deposits. Remember the Lehman Brothers' mini-bonds sold via Hong Kong banks? What happened to those who lost money when Lehman Brothers fell? By and large, banks eventually made good on that loss. Yes, most retail investors had signed before buying the bond a piece of paper saying that they understood the distinction of a bank's liability and a third-party Lehman bond distributed by the banks. But when a crisis struck, some retail investors claimed that they were mis-sold, and they were just "simple people" who did not understand the distinctions. In China, politicians would pick up the phone and the banks would quietly push the loss down their own throat.
In 2012, Chinese banks had a 2% average cost of funding. But why do banks shoot themselves in the foot by offering WMP at a cost of 4% to 6%? I consider WMP just a way for banks to prevent their deposits from fleeing to ... shadow banks like us microcredit firms or trust companies. That's confirmation that a fair market price for deposits should be 4% to 5%, rather than the regulated bank deposit rates of 2%.
Observers worry about an imminent crisis as a result of the rapid growth of shadow banking. I think the fear is misplaced. Chinese banks are still very liquid, and the central bank still has massive power to control the situation. A crisis is at least some years down the road, in my view.
My book has two parts. The first part is about how I left UBS two years ago for a microcredit firm in Guangzhou; how I lobbied hard for the Chinese government to deregulate the industry; and how I went about actually running the business. Part two of the book argues that China's financial repression (negative real interest rates) has caused severe consequences.
I urge you to ask this question: despite the government's hostility towards shadow banking, why is it growing so fast? I think the answer is simple: 1) Savers want a better deal and 2) Deprived SMEs want access to credit, albeit at much higher rates.
For over three decades, China has had a very inflationary monetary policy that is now untenable. Credit grows fast which fuels inflation. Inflation, in turn, means that you need more credit to facilitate the same amount of business activity. And that credit growth leads to more inflation, and then more credit. The interbank scare we saw last week shows that, once you are in that vicious cycle, no amount of credit will satisfy the insatiable demand for credit. The faster credit grows, the more the demand for, and the more shortage of, credit. It's just that simple!
The Chinese government must accept that its economy has grown too quickly for too long, partly (if not mainly) on fiscal and monetary stimulus. The stimulus has caused a lot of problems. First, their effectiveness is diminishing. Second, they caused massive inflation. I mean true inflation not the official statistics of inflation. Third, there is the fact of social inequality. Not everyone has equal access to credit.
China must slim down, and become more efficient. Interest rates must rise. Last week's scare shows that if the government does not raise rates, the market will do it.
Distortions in price signals can last for a long time. They hurt the country, and the poor in particular. We live in a monetary illusion: lousy investment targets appear feasible mainly because of artificially low interest rates.
The Chinese real estate market and the stock market are massively overpriced due to regulated interest rates. While at a micro and operational level (risk assessment, etc), Chinese banks are doing better and better, this improvement can be defeated by a macroeconomic policy of financial repression. If China is not careful, its credit bubble will be the origin of the next subprime crisis. How and when that will happen I do not know, but we seem to be sowing the seeds of a crisis.
I am biased. But as a shadow banker, I acknowledge that shadow banking can undermine the formal banking industry. If the government were really concerned about it, there is a simple solution: liberalize interest rates, or at least raise the rates substantially. That way, shadow banking will shrink.
Thank you. I look forward to your questions.
Joe Zhang is Chairman of Wansui Micro Credit Company in Guangzhou, and author of "Inside China's Shadow Banking: The Next Subprime Crisis?". The book is available at Amazon and Kindle as well as major bookstores.
Thank you for having me here today. In the past two years, I have run a microcredit firm in Guangzhou, having invested in a couple of other similar companies. In April, I had a burning desire to write a book about shadow banking in China. In May, the book came out entitled "Inside China's Shadow Banking: The Next Subprime Crisis?". Soon, my former colleagues at the central bank in Beijing started to promote my book, albeit by accident. As a result, the book is selling very well.
Thank you very much.
What do you make of the saga last week in the Chinese interbank market? The media say there was a cash crunch on the part of the central bank. Really? I must say I find this hard to believe. With broad money supply growing at about 16% every month (on a very high base), is there a cash crunch? China has one of the most inflationary monetary policies in the world, much more so than QE2 or QE3 in the United States or Japan.
Forget about the technical nuts-and-bolts of the interbank market; what I see in China is a banking sector that has expanded credit much too quickly, and some banks have been caught in a maturity mismatch. Unlike the past two decades, the central bank suddenly became less willing to accommodate those who use the interbank as a staple funding source, and those who use the central bank as the lender of first resort, rather than the lender of last resort.
This morning, my sister in central Hubei Province called me to ask if she should roll over a wealth management product as interest rates had suddenly jumped to more than 5% from 4%. I myself also got a text message from my client adviser at Merchants Bank telling me that there was a superb deal available. The scare last week has clearly had a ripple effect. Both my sister and I regularly buy wealth management products, and I tell you that I do not have the slightest concern about their asset quality. I argue in my book that their quality is either at par or better than bank deposits.
Looking at China's 6000+ microcredit firms, thousands of pawnshops, and particularly thousands of curb-side lenders (many of which are huge in size), I find that their asset quality is terrific. Why? We are very nimble compared to banks, and we get to cherry-pick our customers. Second, we are using our own hard-earned money, and thus we are careful. Finally, the current operators are mostly survivors of "jungle justice," and they care little about academic elegance and are street smart.
What about banks' wealth management products? Hey, they are no different from bank deposits. Remember the Lehman Brothers' mini-bonds sold via Hong Kong banks? What happened to those who lost money when Lehman Brothers fell? By and large, banks eventually made good on that loss. Yes, most retail investors had signed before buying the bond a piece of paper saying that they understood the distinction of a bank's liability and a third-party Lehman bond distributed by the banks. But when a crisis struck, some retail investors claimed that they were mis-sold, and they were just "simple people" who did not understand the distinctions. In China, politicians would pick up the phone and the banks would quietly push the loss down their own throat.
In 2012, Chinese banks had a 2% average cost of funding. But why do banks shoot themselves in the foot by offering WMP at a cost of 4% to 6%? I consider WMP just a way for banks to prevent their deposits from fleeing to ... shadow banks like us microcredit firms or trust companies. That's confirmation that a fair market price for deposits should be 4% to 5%, rather than the regulated bank deposit rates of 2%.
Observers worry about an imminent crisis as a result of the rapid growth of shadow banking. I think the fear is misplaced. Chinese banks are still very liquid, and the central bank still has massive power to control the situation. A crisis is at least some years down the road, in my view.
My book has two parts. The first part is about how I left UBS two years ago for a microcredit firm in Guangzhou; how I lobbied hard for the Chinese government to deregulate the industry; and how I went about actually running the business. Part two of the book argues that China's financial repression (negative real interest rates) has caused severe consequences.
I urge you to ask this question: despite the government's hostility towards shadow banking, why is it growing so fast? I think the answer is simple: 1) Savers want a better deal and 2) Deprived SMEs want access to credit, albeit at much higher rates.
For over three decades, China has had a very inflationary monetary policy that is now untenable. Credit grows fast which fuels inflation. Inflation, in turn, means that you need more credit to facilitate the same amount of business activity. And that credit growth leads to more inflation, and then more credit. The interbank scare we saw last week shows that, once you are in that vicious cycle, no amount of credit will satisfy the insatiable demand for credit. The faster credit grows, the more the demand for, and the more shortage of, credit. It's just that simple!
The Chinese government must accept that its economy has grown too quickly for too long, partly (if not mainly) on fiscal and monetary stimulus. The stimulus has caused a lot of problems. First, their effectiveness is diminishing. Second, they caused massive inflation. I mean true inflation not the official statistics of inflation. Third, there is the fact of social inequality. Not everyone has equal access to credit.
China must slim down, and become more efficient. Interest rates must rise. Last week's scare shows that if the government does not raise rates, the market will do it.
Distortions in price signals can last for a long time. They hurt the country, and the poor in particular. We live in a monetary illusion: lousy investment targets appear feasible mainly because of artificially low interest rates.
The Chinese real estate market and the stock market are massively overpriced due to regulated interest rates. While at a micro and operational level (risk assessment, etc), Chinese banks are doing better and better, this improvement can be defeated by a macroeconomic policy of financial repression. If China is not careful, its credit bubble will be the origin of the next subprime crisis. How and when that will happen I do not know, but we seem to be sowing the seeds of a crisis.
I am biased. But as a shadow banker, I acknowledge that shadow banking can undermine the formal banking industry. If the government were really concerned about it, there is a simple solution: liberalize interest rates, or at least raise the rates substantially. That way, shadow banking will shrink.
Thank you. I look forward to your questions.
Joe Zhang is Chairman of Wansui Micro Credit Company in Guangzhou, and author of "Inside China's Shadow Banking: The Next Subprime Crisis?". The book is available at Amazon and Kindle as well as major bookstores.
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