Tangled Christmas Lights: Why You Should Fear China’s Shadow Banking System

There are any number of ways you can go about illustrating why it is that people are so concerned about the potential fallout from China’s ongoing effort to deleverage the financial system.

The problem comes in when you try to extrapolate from those illustrations. That is, you can look at the charts and you can clearly see there’s a problem, but it’s not at all clear how to go about fixing it.

Have you ever tried to untangle a string of Christmas tree lights that you hastily stuffed into a box when you took the tree down the previous year? Yeah, it’s a lot like that. You know it’s a fucking mess, but you’ve got no idea how to go about fixing it.

Here’s how SocGen framed it earlier this month:

Mind-boggling cross-holdings

As we alluded to above, banks often hand over some of their on-balance-sheet and WMP portfolio to third-parties (NBFIs) to manage for convenience and/or higher returns. And NBFIs sometimes pass on some part of this money to yet other counterparties that can be more risk-loving. Therefore, there exists a significant amount and a complex web of cross-holdings between banks and NBFIs as well as among NBFIs. Consequently, it is nearly impossible to have a clear idea who is responsible for what when things go wrong. The danger is that since banks are the ones directly facing the mass market of retail investors, they may be cornered to internalise most of the credit risk at the end of the day.


And if you had to choose one chart that illustrates the point SocGen was trying to make in that paragraph, you might very well choose this one, from Citi:


Or, depicted differently…



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