Bill Savadove Shanghai

A shock wave is looming in China’s multitrillion-dollar “shadow banking” system, with an unprecedented default only days away on a $500 million (R5.5 billion) investment product that has been sold to hundreds of people.

Staff at China’s biggest bank, the Industrial and Commercial Bank of China (ICBC), pushed the “Credit Equals Gold #1 Trust Product” by promising returns of 10 percent a year, far more than traditional deposits, investors say.

ICBC ownes a 20 percent stake in Standard Bank.

But the coal company it was supposed to fund had never obtained key licences for its activities, state media reported, and now the firm that structured it, China Credit Trust, says it may not be able to repay 3 billion yuan (R5.4bn) due last Friday.

The situation is a test case for cleaning up the risky so-called shadow banking system in the second-largest economy.

Analysts said the government could use a default to send a message about the danger of speculative investments, while showing Beijing’s commitment to reining in the vast pools of capital threatening financial stability.

But at the same time, authorities must walk a fine balance between cracking down and preventing protests by angry investors – as well as setting off a chain reaction that sharply tightens credit in an economy where growth is already slowing.

Chinese shadow banking is a massive network of lending outside formal channels and beyond the reach of regulators, including activities by online finance platforms, credit guarantee firms and microcredit firms.

The market was as large as $4.8 trillion in 2012, more than half the country’s gross domestic product, according to an estimate by ratings agency Moody’s Investors Service.

China’s powerful State Council, or cabinet, reportedly issued internal guidelines last month to crack down on the sector.

But ratings agency Fitch Ratings said in a report: “The reforms may seem like a good beginning, but they have a long way to run.”

China Credit Trust sold the investment product from 2010 through branches of ICBC, to around 700 of the bank’s high-net-worth clients.

The trust channelled the funds to Zhenfu Energy in the country’s mining heartland of Shanxi province. But the firm’s owner was detained by authorities in 2012, state media reported, raising questions over the viability of the firm.

“ICBC and China Credit Trust dug a hole, covered it with a straw mat and told us to jump in,” said Gao Yiyang, an investor who spent almost $500 000 of his family’s money on the product. It now appears our money was not used for any of the company’s actual operations. It was purely fraud to get our money to fill a huge deficit hole.” – Sapa-AFP