A well researched article in FT.com warns about the exponential growth of shadow banking system in China and the potential fallout in future.

Wealth Management Products (WMPs) are emerging as alternate asset of choice for investors in China seeking better returns than the bank deposits. Mainstream banks in China offer regulated and ultra-low interest rates on their deposits. WMPs are high yield investment products that invest in risky businesses typically shunned by mainstream banks.

Most WMP pools are dependent on new fund inflows to keep afloat and to offer interest on the instruments previously sold. This is not new and sounds similar to many ponzi schemes that have been devised over the years. It gets more complicated in China.

In China, Banks are allowed to sell WMPs and leave them in off balance sheet entities. Most WMPs do not disclose where they invest, somewhat like what hedge funds do. Banks also tend to transcat in each other’s WMP product creating a complex off-balance sheet web of money flow. You are not way of the mark in thinking that Banks are officially selling Ponzi schemes.

Last year alone, Banks issued WMPs worth more than 20tn Yuan, roughly one third of China’s GDP. Banks offer them as alternate investments to deposits but never tell them the risks or where the money will be invested.

To solve this complex issue, the central bank of China came up with a simple solution. It said the short term off balance sheet assets will not be included when reporting the size of shadow banking system!