Chinese financial conglomerate Zhongzhi Enterprise Group has warned that it is insolvent, with liabilities reaching nearly $64 billion, sending shockwaves through the country’s banking system. Authorities have opened multiple investigations into the firm over allegations of illegal fundraising and other suspected crimes. The unfolding crisis spotlights the mounting risks in China’s shadow banking sector amid a prolonged property slump.
Zhongzhi Admits to Being "Severely Insolvent" After Failing to Repay Investors
Beijing-based Zhongzhi sent letters to regulators last week saying it was "severely insolvent" and had failed to repay investment products on schedule, according to a notice on its website. The company blamed its predicament on misjudgments in its risk controls and investment strategies, as well as turmoil in the domestic and overseas economic and financial environment.
Zhongzhi warned that it was facing a shortfall of at least 300 billion yuan ($41 billion) in investable assets – meaning huge losses for investors. The group had total assets under management of nearly 1 trillion yuan ($140 billion) as of June 2022 across trust, securities, insurance, banking and other businesses.
|Total Assets Under Management
|Estimated Asset Shortfall
This is a severe blow for a major Chinese wealth management company that oversees the money of millions of retail investors. The unfolding crisis spotlights the still underappreciated risks in China’s financial system, especially at smaller banks and in the vast shadow lending sector.
Police Launch Investigation, Detain Former Chairman
Beijing police said Saturday they have opened an investigation into alleged illegal fundraising and other suspected crimes related to Zhongzhi. Police detained Ye Jianming, Zhongzhi’s former chairman, for suspected illegal fundraising though he is no longer in charge of the group’s day-to-day operations.
Several other senior executives have also been detained in relation to the case. Zhongzhi’s risks spiked as China’s economic slowdown deepened thanks to disruption from COVID outbreaks and a real estate crisis. The situation deteriorated as global interest rate hikes made financing conditions much tougher for overstretched Chinese firms.
Analysts have warned for years that small banks, trust companies and other fund managers faced mounting risks as China’s economic slowdown deepened, dragging down the property sector which accounts for 25-30% of Chinese GDP. Zhongzhi’s woes have intensified investor worries about thinly-capitalized small banks and the vast Chinese shadow banking industry.
Exposure Across Multiple Sectors Increases Contagion Risk
Zhongzhi has extensive exposure across China’s economy spanning real estate, infrastructure, aviation, and healthcare. Its collapse could have a cascading impact across multiple sectors. Zhongzhi’s known financing channels include banks, trusts, securities firms, insurers, public offerings, and internet platforms.
The group relies heavily on borrowed money to invest – increasing contagion risks. It has outstanding bonds worth nearly 18 billion yuan ($2.5 billion). Zhongzhi units also owe nearly 40 billion yuan to China’s four biggest banks, according to Caixin. Its woes may further hit confidence in China’s $4.3 trillion trust industry.
Regulators Vow to Maintain Stability Amid Gathering Storm Clouds
Chinese financial regulators held emergency meetings with banks and other institutions to assess their exposure to Zhongzhi. In one meeting, a senior banking regulator vowed to "maintain stability of the financial sector", saying risks were still manageable.
However, Zhongzhi’s collapse comes as China grapples with its biggest property slump on record. At least 28 Chinese developers have now defaulted on their dollar debt. The mounting defaults have already triggered social unrest and buyer protests in dozens of cities in recent months.
Beijing has rolled out a flurry of stimulus and easing measures to stabilize its COVID-battered economy after growth slid to just 3% last quarter – one of its worst rates in around half a century. While officials publicly talk about maintaining stability, they are clearly increasingly worried about contagion risks. Expect regulators to quietly pressure banks and other institutions to absorb losses to try and contain the gathering storm clouds.
Troubles May Worsen as Economy Slows Further in 2023
Most analysts expect China’s economy to slow further in 2023 amid still-strict COVID curbs, a worsening real estate slump and feeble domestic demand.
Goldman Sachs forecasts just a 4.5% GDP expansion this year while Oxford Economics is even more bearish – projecting growth under 4%. This suggests more financial landmines may lurk across China’s $52 trillion banking system and vast unregulated shadow lending sector.
Trust firm failures and small bankruptcies seem inevitable given the darkening outlook. The key question is whether authorities can contain the spreading systemic risks. The answers will determine the extent of economic and financial damage in 2023 – and beyond.
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