Image Source: CNN

A financial crisis is brewing in China as a major shadow banking company has stopped making payments, putting billions of dollars of investments at risk. The unfolding debacle spotlights the government’s struggle to contain the fallout from its property sector woes.

Zhongzhi Enterprise Group, a private conglomerate managing over $140 billion in assets, failed to pay investors starting in July through its trust subsidiary Zhongrong International Trust. The missed payments total over $1 billion so far across dozens of investment products.

With over 300,000 investors facing uncertainty, panic has set in. Yet Zhongrong has not provided any timeline for repayments, fueling worries that one of China’s largest shadow banks may be headed for collapse.

Trust Products Widely Seen as Backed by Government

Zhongrong manages around $86 billion in investments for clients looking to generate higher yields. The trust company sells so-called wealth management products to Chinese companies, institutions, and retail investors.

These products pay out much more than typical bank deposits. Zhongrong’s offerings promised annual returns up to 10.1%, attracting huge interest.

Although the investments are risky, many assumed Zhongrong had implicit government backing. Its largest shareholder is state-owned Jingwei Textile Machinery. Zhongzhi Group also has ties to major state-owned Datang International Power Generation.

This perceived state support led trusting investors to pour savings into Zhongrong’s products without fully considering the risks. The crisis has shattered the long-held belief that trust firms were shielded from failure.

Property Crisis Restricts Lending, Strains Financial System

Zhongrong’s woes originate from China’s real estate troubles. As property developers face mounting debt problems, it constrained lending in the shadow banking sector tied to real estate.

Trust firms like Zhongrong relied heavily on the booming property market, providing financing to developers through risky loans. Now as new home sales dry up, many borrowers can’t repay debts on time, putting trust firms under intense strain.

The cash crunch has rippled through China’s complex financial system. Banks also lent aggressively to real estate. The combined impact has tightened credit conditions considerably, dragging on the world’s second-largest economy.

“Zhongrong’s problems are the latest ripple effects from China’s property crisis, which is wreaking havoc in the country’s financial system,” said Daisuke Wakabayashi, a financial reporter.

The crisis presents a tough balancing act for Beijing as it tries to shore up the economy while limiting bailouts of troubled firms.

Regulators Cracking Down on Shadow Banks

Trust firms like Zhongrong operate in the shadow banking sector, which Beijing has been trying to rein in due to concerns over excessive risk-taking.

Shadow banks helped drive China’s debt to almost 300% of GDP. They extended loans loosely to real estate developers and local governments beyond what traditional banks offered.

Starting in 2016, regulators tightened oversight to curb reckless lending. In 2018, authorities seized control of Anbang Insurance Group and imposed strict leverage caps on financial conglomerates like Tomorrow Holdings.

Two years later, Beijing took over nine financial firms including Baoshang Bank and Huaxia Bank to contain credit risks. More recently, authorities have allowed some shadow banking failures to proceed.

But widespread trust in state backing made investors overlook risks until now. The Zhongrong crisis reveals the systemic vulnerability of China’s shadow banks to the downturn in real estate.

Investor Panic as Firm Stays Silent on Repayment

Zhongrong’s brief statement blamed “multiple internal and external factors” for preventing payments. But it gave no timeline on when investors would get their money back.

Many investors had placed lifesavings into Zhongrong’s products. “It’s like my heart is bleeding every day,” said Ms. Wang, an accountant who fears losing her $1.5 million investment.

As anxiety rises, over 1,000 people protested at Zhongrong’s headquarters in Beijing, demanding the company return funds. Some investors tried lodging complaints with regulators.

But with little recourse, desperate citizens are calling for the government to step in. “Zhongrong cannot become China’s Lehman moment,” said Guo Shuqing, chairman of the China Banking and Insurance Regulatory Commission.

Yet regulators have stayed silent so far. The lack of clarity on whether Beijing will intervene to contain the crisis has further shaken market confidence.

Government Reluctant to Engineer Bailout

While investors clamor for a state rescue, the government might be unwilling to orchestrate a bailout, analysts say.

Past interventions led to moral hazard, allowing financial firms to ignore risks when raising money. But letting major institutions fail risks sparking panic and social instability.

“In the past, Beijing embraced bailouts to keep credit flowing for growth,” said Logan Wright of Rhodium Group. “But now its debt-fighting strategy is coming to an end.”

In 2020, Beijing seized control of two troubled trust firms, letting them falter. Last year, Xinhua Trust became the first trust to declare bankruptcy in over 20 years.

This signaled the state is no longer on the hook for all shadow bank failures. But the enormous scale of Zhongrong’s woes will test its resolve to stay the course.

Government Policy at Critical Juncture

The Zhongrong crisis thus represents a critical juncture for China’s policy direction.

With people’s savings at stake, social tensions could boil over if the government is seen as doing too little. However, easing credit again to bail out institutions would undo years of deleveraging efforts.

“China’s policymakers now face a predicament,” said financial analyst Louis Lu. “They could stay the course and risk stability. Or revive credit growth but undermine reform progress.”

How Beijing navigates this challenge could determine whether China’s economy heads for a sharp slump or manages a soft landing. Much hangs in the balance as authorities weigh competing policy aims.

The coming weeks will offer key insight into the government’s thinking as it responds to Zhongrong’s troubles. For now, the firm’s opacity and investor confusion persists.

Outlook Remains Murky for Investors

Despite the storms brewing in China’s financial system, Zhongrong has not provided any clarity to anxious investors awaiting word on their funds.

Some feel misled by the apparent state links from Zhongrong’s shareholders. “I thought with state backing, the investments were safe,” said a Zhongrong investor surnamed Chen.

The firm brought in two state groups to offer support, but the specifics remain unknown. Some investors still believe the government won’t let them down despite regulatory tightening in recent years.

But Beijing is facing mounting pressure both at home and abroad. Its strict zero-COVID policy led to extensive lockdowns, fueling widespread frustration. The global economy also teeters toward recession.

With challenges on multiple fronts, the government has limited capacity to engineer bailouts like in the past. For now, little light shines through the fog of uncertainty clouding China’s shadow banks.

The still-unfolding crisis at major firm Zhongrong serves as an alarming wakeup call on China’s financial vulnerabilities. How events proceed here will have pivotal implications on growth prospects and social stability.