Zhongrong International Opens New Offshore Funding Routes for China’s Shadow Banks

Written by Erin Smith || June 29 2015

Earlier this month, Zhongrong International Trust became China’s first issuer of offshore bonds, beginning the Chinese trust industry’s venture into international capital market. This exemplifies the great expansion the Chinese trust industry has experienced in recent years.

Indeed, the industry has grown considerably in the past decade to the point where trust companies have taken up the second largest segment of China’s financial sector, behind commercial banks. However, this growth and the opening up of trust companies to the international market brings with it concerns over the expansion of shadow banking and rising default rates in China’s economy.

Shadow banking has been a huge concern for economists and investors alike, and has been considered one of the great failings of the financial system that led to the global economic crisis in 2008. Shadow banks are financial intermediaries that function by creating credit across the global financial system. However, members of these financial intermediaries are not subject to regulatory oversight in the way traditional commercial banks are. Examples of these intermediaries not subject to regulation are hedge funds, unlisted derivatives and other unlisted instruments. Shadow banking also manifests itself as unregulated activities by regulated institutions, such as credit default swaps.

The accelerated expansion of China’s shadow banks has been a concern since at least 2008, when shadow banking began rapidly expanding. Trust companies like Zhongrong International Trust had a role in this expansion. By packaging bank loans into products of wealth-management or acting as a trustee for products originating from banks, trust companies have assisted shadow banks in expanding into the massive scale where they stand today. With Chinese trust firms gaining a foothold into international capital markets, the shadow banking sector may expand even further.

Some worry that not enough is being done by the government to halt the growth of shadow banks in China. Initially, the shadow banking sector mainly focused on property and investments by local governments. Now, shadow banks are moving towards China’s thriving stock markets. With the momentous first issues of offshore bonds by a Chinese trust firm, there are concerns that this will lead to the expansion of shadow banking into the international capital market.

In addition, there exist some concerns about the lending standards of Zhongrong International and other trust firms in China. In the previous year, economic growth slowed and default rates rose in China as many blamed the lack of lending standards and safeguards to protect against default for the slowing economy. In particular, Zhongrong International had extended loans to Shanghai Chaori Solar Energy Science and Technology, which became the first company on a domestic Chinese bond to default last year. With the announcement of China’s first issuing of offshore bonds, there are worries about lending standards in the international market by Chinese trust firms like Zhongrong International.

Despite these concerns, Zhongrong International Trust has great aspirations for its future. Currently, they are the second largest trust company in China, with assets of RMB 710.6 billion at the end of last year. While presenting to its investors, Zhongrong International claims that it wants to focus on private equity, wealth management and asset management as an integrated asset manager. Zhongrong International’s foothold into the international capital market gives room for a lot of growth for Chinese trust companies. However, it remains to be seen what effect this has on the expansion of shadow banks and lending standards.