The property sector in China,which once accounted for about 30 per cent of the country’s GDP,is deeply connected – not just to its banking system,but also its shadow banking sector,or trust industry.

The trusts raise funds from households and companies by offering far higher returns than conventional banks (as much as 8 per cent versus less than 2 per cent from the banks),which they then invest in a range of assets,including stocks,bonds and commodities – and the financing of property developments.

The $4.5 trillion sector’s official exposure to property is claimed to be only about $235 billion,but,given the complexity and opaqueness of the sector,is likely to be far larger.

The sector also has exposure to local government financing vehicles that are themselves heavily exposed to the sector because of local government’s reliance on land sales for as much as half their revenues.

Those off-balance-sheet vehicles,and the local government on-balance-sheet finances,are causing significant concern in Beijing,which recently dispatched teams of inspectors and advisers to the more leveraged jurisdictions.

The authorities have also directed two of the country’s bigger financial firms to inspect the books of one of the larger trust companies,Zhongrong International Trust Co,after it missed payments to an estimated 150,000 investors on a raft of investment products in recent weeks.

Real estate loan volumes are at their lowest levels since the 2008 financial crisis,signalling the defensive mood among households and investors.

Zhongrong manages more than $210 billion of funds,largely from wealth investors,and Beijing appears concerned that its connections with property developers and other financial institutions represent a risk to the wider financial system and economy.

Zhongrong and a number of its peers are said to have bought into a number of large property projects last year,betting that the market would stabilise and then rebound. Instead,sales numbers and value have kept falling – and the losses would have kept mounting.

The trust group isn’t the first in its sector to experience distress. Early on in the slow-motion implosion of the property sector,the authorities seized control of a number of trust groups after they failed to make scheduled payments to their investors.

Earlier this year New China Trust became the first of the trusts to be declared bankrupt in more than two decades. Generally,however,when the larger trust groups and other shadow banks have become distressed,they’ve been bailed out rather than allowed to collapse and spread contagion through a sector vulnerable to investor panic and “runs”.

The alacrity with which the central authorities respond to issues within the trust sector is an indication of the degree of concern they have about the potential for the distress of one of the big trusts to cascade – and not just through the trust system as investors take fright,but into the broader financial system and economy.

The authorities have tried to stabilise the property sector,reducing interest rates,relaxing mortgage restrictions and encouraging banks to do more mortgage lending,but real estate loan volumes are at their lowest levels since the 2008 financial crisis,signalling the defensive mood among households and investors.

Theabrupt shock the property sector got in 2020 when Xi Jinping imposed his “three red lines” limits on developers’ leverage,to try to dampen debt-driven speculative activity and over-building,initially hit the developers and their bondholders – and subsequently households that had pre-purchased apartments yet to be built,suppliers and local governments – and now is surfacing among the secondary-level financiers.

There is a destructive cycle that has developed – one that threatens the stability of the shadow finance sector and,perhaps,elements of the conventional banking system – that will be difficult to arrest,given that losses and contagion will continue to pour through the already-fragile property-related activity until the sector is stabilised and household confidence eventually returns.

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