Shadow-banking bailout chills emerging markets

A struggling $500m Chinese investment vehicle known as a trust product has secured a last-minute bailout, potentially averting a bigger crisis.

Credit Equals Gold No. 1, which had been marketed to rich individuals, had promised an annual return of 10% for three years. It was based on loans to a coal miner that collapsed, along with the price of coal. Investors will get most of their money back, thanks to a bank and a local government coming to the rescue.

Potential turbulence in China’s so-called shadow-banking system – non-bank institutions and investment vehicles lending to firms that can’t get credit from mainstream banks – is another reason emerging markets have slumped in recent days.

The selling continued into mid-week, with interest-rate hikes by central banks in Turkey, India and South Africa doing little to stem the tide.

What the commentators said

You can see why the potential default of a trust product has “created a chill in China and beyond”, said Markit’s Gavan Nolan. The shadow-banking system, of which wealth-management products and trust loans are the main part, provided a third of new credit in China in 2013.

The products are frequently opaque, but because they are sometimes marketed through banks, investors have assumed they are safe. They resemble “[US] subprime mortgages and the… vehicles into which they were packaged”, said Randall W Forsyth in Barron’s. “In both cases, the allure was higher yields than those [on] conventional investments.”

As the era of easy credit draws to a close, the strain in the system is becoming evident, said Aaron Black in The Wall Street Journal. Over 20 trust products worth more than $3.9bn have run into payment problems since 2012. Sales of trust products have plummeted, and with less money coming in trusts will struggle to roll over short-term loans to stressed borrowers.

It seems that “at least some Chinese investors may be slowly waking up to the fact that there aren’t enough white knights to save everyone”.

The worry is that a series of defaults could ricochet through the system and cause a widespread collapse, just as the subprime problem did.

Given the economy’s dependence on cheap credit and the “magnitude of the explosion in credit in recent times”, said Nolan, that could prove very unpleasant indeed.