China in fresh shadow banking crackdown

Posted on July 29, 2016

The China Banking Regulatory Commission in Beijing, China©Bloomberg

China is preparing new rules to tackle risks from shadow finance by curbing the issuance and portfolio mix of the “wealth management products” that have fuelled the huge increase in Chinese corporate debt since 2008.

WMPs, which allow banks to channel credit to local governments, property developers and overcapacity industries that struggle to access normal bank loans, have surged from Rmb1.7tn at the end of 2009 to Rmb23.5tn by the end of last year, according to Wind Information. 

    By recording WMPs off-balance-sheet, or by classifying them as “investments” rather than loans, banks are able to report higher capital adequacy ratios and set aside less provisions against bad loans.

    The China Banking Regulatory Commission has drafted rules that would limit the size of lenders’ WMP issuance based on their total balance sheet or deposits, 21st Century Business Herald reported this week. The draft rules also restrict the share of equities and so-called “non-standard” assets — mainly illiquid loans — within a single WMP. If adopted, the change would force WMPs to rely more on bonds and money-market assets, which are less risky but offer lower yields.

    “The CBRC move highlight[s] the leadership’s focus on controlling financial risks. This focus from the very top of the leadership, as well as the recent high-profile dispute involving big property developers, has led to the heightened vigilance of regulators,” Goldman Sachs analysts led by chief China economist Yu Song wrote this week. 

    The rules would also forbid banks from issuing structured products made up of multiple tranches, each with different levels of risk. Multi-tranche products have become increasingly popular, with subordinate tranches using leverage to increase yields. Structured WMPs channelling funds into the stock market helped fuel last year’s boom and bust. 

    WMPs have also added significant complexity to China’s financial system, creating difficulties for assessing risk. Rating agency Moody’s warned this week that data from China’s central bank on “total social financing”, which is meant to capture corporate and household credit from all sources, understates economy-wide leverage by Rmb16tn. Loans packaged into WMPs are the biggest sources of hidden credit, with small and midsize lenders most active. 

    Finally, the regulations would restrict banks’ ability to partner with non-bank financial institutions like brokerages, fund management companies, and insurers to move loans off their books.

    Industry observers caution that the draft rules are still subject to change and that much depends on enforcement. Banks and regulators have engaged in a cat-and-mouse game since 2011, with lenders creating new, more complex transaction structures in response to regulations targeting established practices. 

    “This draft looks very strict but we’ve seen efforts like this before,” said a person close to regulators. “A lot depends on implementation.” 

    Additional reporting by Ma Nan

    Twitter: @gabewildau

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