Inside China

Behind China's shadow banking system

Behind China's shadow banking system
Behind China's shadow banking system

Off-balance-sheet loans are at the heart of China's shadow banking system, a $6 trillion annual industry.

The government has taken steps to coordinate regulation and improve oversight of the financial system—an effort to get a handle on the size and scope of the shadow market.

Many of these shadow loans come from banks, but not all of them—even private citizens are lending out their savings to companies looking for extra cash.

The questions about the Chinese banking system add to broad concerns about the country's economy. Some skeptics take issue with the government's economic data making the country appear stronger than it is.

At the same time, the government has said people in monetary policy anytime soon.

The concerns about China's banking system do not stand in isolation, though; investors are generally worried about emerging markets after a broad sell-off in recent days.

Indonesian stocks fell a further 4.5 percent to enter bear market territory and India's rupee fell to new record lows against the dollar. Turkey's central bank hiked interest rates by a surprise 50 basis points as it tried to stem the decline in the lira.

European stocks also experienced broad declines and analysts said there would be no let up in the correction until the Fed provides further clarity on its bond-buying policy.

Since last week, global markets have traded lower on fears that the Fed will start to taper its bond purchases as early as September. On Monday, the Dow and logged their first four-day losing streaks this year and 10-year Treasury yields hit a two-year high of 2.88 percent.

(Read more: Bond exodus accelerates as yields creep nearer 3%)

"This simply doesn't look like a market that is going to see lower yields, at least without some serious verbal intervention from the Fed," Chris Weston, chief markets strategist at trading firm IG told CNBC on Tuesday.

(Read more: September or December taper-does it really matter?)

According to him, emerging markets had seen inflows of an estimated $4 trillion from successive rounds of Fed easing but that was now being "unwound at a rate of knots."

That outflow of money has hammered emerging market currencies. India's rupee has declined 15 percent since the start of the year against the dollar, while Brazil's real has fallen by 18 percent.

"Countries that have reasonable levels on inflation, run large current account deficits and continue to face worrying capital flow prospects are getting absolutely destroyed and remain vulnerable," Weston said. The underperformance was likely to continue as the starting point of Fed tapering nears, analysts Hamish Pepper and Koon Chow at Barclays said on Tuesday.