Zhongzhi is the latest victim of China's worsening debt and property crisis

China's shadow banks operate by pooling the savings of households and businesses to make loans for investment in real estate, stocks, bonds and commodities. Companies like Zhongzhi have often financed many major Chinese real estate developers.

Zhongzhi has been warning of its dire financial situation since August, when Reuters reported that the company told investors it was facing a liquidity crunch.

He then declared bankruptcy in a letter to his investors in November, and soon after Beijing police launched an investigation into the debt-ridden shadow bank.

“Although the company's creditors are mostly wealthy individuals rather than financial institutions, its collapse could damage overall confidence in the market. It could also renew concerns about the trust industry and whether it would have broader and significant implications for the struggling property industry.” In Commerzbank wrote in the client note.

The broader CSI 300 index was down 1.2% by afternoon, dragged down by real estate stocks.

Shares of Hong Kong-listed property companies including Logan Group, China Vanke, Sunac and Longfor Group fell between 2% and 3.6%.

In the past few years, the Chinese government has tried to curb the rapid growth of non-bank debt issued by shadow banks.

China's largest banks are state-owned, making it difficult for non-state-owned companies to tap traditional banks for financing, which has helped spur the rise of shadow banking.

The country's huge real estate sector has also been caught in the middle of a crackdown on the shadow banking system that real estate companies used to buy land from local governments.

“We don't expect a government bailout because many of Zhongzhi's products are non-standard wealth management products that have long been discouraged or banned by Chinese regulators; some of them are comparable to a Ponzi scheme,” Zerlina Zeng, senior credit analyst at CreditSights, told CNBC's Squawk. “. Asia Fund.

“We are likely to see more credit loan defaults because their primary investments are local government financing instruments and real estate debt…Local governments are likely to continue to prioritize public debt at the expense of credit loans,” Zeng warned.

China's real estate market has been suffering from a debt crisis since 2020, with real estate giants such as Evergrande and Country Garden struggling to repay receivables. Its cash flows dried up, largely due to declining home sales.

Growth in home sales and prices has remained sluggish, but Beijing has begun a broader deleveraging process in the once-bloated real estate sector – which directly and indirectly accounts for about a third of China's economic activity.

— CNBC's Clement Tan and Evelyn Cheng contributed to this story.