2023-11-27 17:10:36
Chinese authorities sanctioned officials of Zhongzhi Enterprise Group, one of the largest shadowy financial institutions in China, on Saturday. The difficulties of this conglomerate highlight the weight of this alternative sector in the Chinese economy.
Published on: 11/27/2023 – 6:10 p.m.
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Haro on shadow finance in China. Beijing denounced “illegal crimes” and carried out “criminal coercive measures” – official terminology for arrests – against officials of the financial institution Zhongzhi Enterprise Group (ZEG), Saturday November 25. Expressions that the Chinese authorities reserve for the most sensitive matters, such as during the placement under house arrest of Xu Jiayin, the president of the near-bankrupt real estate giant Evergrande, in September 2023.
This time, Beijing has attacked another pillar of the Chinese economy. Unknown outside Chinese borders, ZEG nevertheless represents “one of the most powerful shadow finance players in China”, underlines Xin Sun, specialist in the Chinese economy at King’s College London. This is a part of the Chinese economy encompassing all the players who finance the economy outside traditional banking circuits.
In this universe parallel to traditional banks, Zhongzhi is one of the first in class. It is a group which lends to both real estate developers and local authorities, and which also manages the billions of dollars that rich Chinese have entrusted to it.
“Severely insolvent”
As such, Zhongzhi Enterprise Group is considered an essential cog in a sector – shadow finance – which has long been a important engine of Chinese growth.
But ZEG is no longer… just a shadow of itself. The arrest of “numerous suspects” by the police is only the latest episode in a rapid descent into hell for the group specializing in parallel finance.
A few days before the intervention of the authorities, Zhongzhi had declared himself “severely insolvent” in a letter sent to investors. More specifically, the establishment indicated that it had amassed at least $59 billion in debt and had only $28 billion in assets. The group’s leaders also admitted that they did not know how to fill this $31 billion hole.
Also read “Ocean Flower Island”, symbol of the madness of grandeur of real estate developer Evergrande
It is a debacle “which had been anticipated since this summer at least”, underlines Xin Sun. In August, the police had already had to intervene at the Zhongzhi headquarters to disperse a demonstration by Chinese who complained of no longer being able to withdraw the funds they had placed in the hands of ZEG’s financiers.
The causes of the fall of the Zhongzhi house are known: “The group is paying the price for the real estate crisis in China and the general slowdown in the economy,” summarizes Xin Sun. Founded in 1995, ZEG has become the symbol of triumphant shadow finance in China over the years.
Much more opaque and less regulated than the traditional financial sector, this alternative banking system often makes it possible to mobilize funds more quickly and offers investments at more advantageous rates than those of traditional establishments.
More than French GDP
The sector took off after the global financial crisis of 2008, “when access to traditional credit became more difficult,” notes the Wall Street Journal. The “shadow” establishments then became the “best friends” of real estate developers and local authorities, quickly requiring astronomical sums to finance their extravagant new infrastructure projects, or to build entire cities out of the ground.
Even traditional banks have “used these alternative structures as intermediaries to lend money to real estate developers,” recalls Xin Sun. They could thus free themselves from part of the rules decreed by Beijing to limit risk-taking.
Shadow finance has established itself as a central part of the real estate boom in China over the past twenty years. And a piece that is very expensive, since the economic weight of shadow finance is estimated at more than 2,900 billion dollars, a little more than the GDP of France (2,639 billion euros in 2022or 2,881 billion dollars).
As long as Chinese growth was good, business was good for these alternative financial institutions. Traditional banks provided them with money which they then knew how to grow, allowing the largest of them to diversify. This is how Zhongzhi became a major fund manager for wealthy Chinese and was able to invest in areas as varied as mining and electric cars, underlines the Financial Times.
But when real estate began to show signs of fatigue, these establishments found themselves faced with developers who were finding it increasingly difficult to repay. Not to mention that with the slowdown in the economy, the investments made by these institutions have become much less profitable than expected. Hence Zhonghzi’s setbacks which are “a good indicator of the state of health of the Chinese economy”, summarizes Xin Sun.
Risk of contagion?
On the other hand, it is much more difficult to assess the consequences of the collapse of this conglomerate. Starting with the effects on the Chinese banking sector. Even less than a decade ago, it might have faltered due to the collapse of a piece of the puzzle of the magnitude of Zhongzhi, but “since 2015, the government has encouraged traditional banks to distance themselves from these institutions, and they are today much less exposed to this sector”, concludes a note from King’s College London on the links between shadow finance and the banking sector, published 2023.
“I don’t think that Zhonghzi’s setbacks will have a contagion effect on the rest of the traditional banking sector,” confirms Xin Sun. On the other hand, the shock wave will certainly be felt throughout shadow finance. “What must be understood is that in recent years, these institutions have reinvented themselves as wealth managers offering more attractive returns than normal banks. But to attract investments, investors must have confidence,” notes Xin Sun.
This is why, beyond just the banking sector, the difficulties of one of the most important players in this parallel financial circuit risk triggering a movement of distrust which could be very costly. Many small and medium-sized businesses in China still depend on the bets these “shadow banks” were willing to make.
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