China More Market Than Many Realize, Internal Finance Risk Edition

Caixin: In Depth: Risks Are Building Up in China’s Internal Finance Companies
In China, these internal finance companies are the subsidiaries set up by conglomerates and other companies to help manage their funds and keep financial risks under control. In some ways, they operate much like the treasury departments of large Western companies — regularly borrowing and lending out money to peers through a variety of short-term debt instruments such acceptance bills and commercial paper. These financial tools help companies cover expenses like payroll as they come up without having to dip into reserves that might be locked up in longer-term investments. At the same time, companies with extra cash on hand can use these same debt instruments to lend out idle funds to other companies in need of short-term funding.

Gradually, however, China’s growing number of finance companies have been scaling up their fundraising via other financial instruments such as bond issuances and large certificates of deposit. They also began using acceptance bills and commercial paper in leveraged financing, with added to the risk of such deals. Regulations have not kept up.
The difference between China and the United States shadow banking system is that where the U.S. can rely on contract law and theoretically (2008 aside), both lender and borrower assume the risk of the transaction, in China there is the assumption of a government backstop. Credit growth had little to no breaks because most participants assume the worst outcome is waiting for return of principal in a case of default.

Credit bubbles do not burst when credit growth stops. Credit bubbles burst when the rate of growth slows. Deleveraging was aborted in 2015 and 2016 because it was tipping into a financial and economic crisis. Is this time different?

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