Page 330 - 2018 White Paper on the Business Environment in China
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8 White Paper on the Business Environment in China
non-traditional players. It can include loans from non- were to be included, the total would be substantially
financial companies as well as investment products. It is higher. Credit continues to flow toward unprofitable
outside the bounds of normal banking regulation, so it projects and unproductive assets that generate little or no
largely goes unregulated.) The agency is also targeting return. Fathom estimates China’s non-performing loans
lending between financial institutions in the interbank problem at close to 30 percent of GDP, over ten times
market. Shadow banks tap interbank funding to add higher than the official estimate. If and when growth falls
leverage to wealth management products in order to below the government’s comfort level, we expect the
offer higher yields. Small- and mid-sized banks, which clampdown on lending to be reversed (Fathom).
rely more heavily on wealth management and interbank
business, are expected to feel the biggest hit from the Moody’s Investors Service says that liquidity in
latest crackdown. The agency’s aggressive moves came China’s financial system is increasingly tightening,
as President Xi Jinping’s anti-corruption campaign as stricter regulatory measures seek to constrain the
shifted focus toward the financial sector. The CBRC is growth of leverage in the country. “At the same time,
targeting complex financial structures in which funds the interconnectedness between mid- and small-sized
circulate between financial assets — offering high yields banks and the shadow banking sector continues to
to investors and generating fee income for lenders — grow, increasing the risk that funding structures could
but do not spur real economic activity by companies become fragile if confronted with a negative liquidity
and households. Banks sell wealth management shock,” says Michael Taylor, a Moody’s Managing
products in partnership with non-bank institutions such Director. In particular, tighter systemic liquidity could
as trusts, securities companies and fund managers. In crystalize the risks inherent in the more complex and
a statement accompanying new policy guidelines, the opaque funding structures used by smaller banks.
CBRC pledged to “thoroughly examine and rectify the These banks are vulnerable to the withdrawal of
problem of transactions with too many participants, wholesale funding, which they have used to finance
complex structures and excessively long chains, which their investments in the trust and asset management
causes funds to ‘take leave of the real and enter the schemes of non-bank financial intermediaries to boost
virtual’.” A key focus of recent policy actions on shadow profitability, as well as to circumvent capital restrictions
banking is to eliminate so-called “regulatory arbitrage” on lending. “The Chinese authorities recognize the risks
between these three agencies. Financial engineers in the shadow banking sector and are seeking to address
have learned to exploit differences between the rules them through a new set of regulatory guidelines,
that govern similar investment products depending on highlighting that preventing financial risks has become
which regulator supervises the institution that issues the one of the government’s top priorities this year,” says
product. Increasingly, wealth management products use George Xu, a Moody’s Associate Analyst. “However,
“nested” structures akin to financial derivatives: a bank there are indications that regulatory measures to curb
may sell one product based on an asset management system-wide leverage show unintended consequences;
plan from a securities company, which is in turn a specifically, in reviving ‘core’ shadow banking activities
derivative of a trust loan. Such complexity makes it that had previously been constrained by regulation,”
virtually impossible for investors to discern the identity adds Xu. Moody’s explains that because of government
of the final borrower or assess default risk. Complexity efforts to constrain the growth of leverage, borrowers
also creates contagion risk because a single default can in sectors such as property, local government financing
inflict losses on multiple institutions with derivative vehicles and overcapacity industries with high financing
exposures (Wildau). needs face reduced access to traditional bank loans and
the primary bond market. As a result, there are increasing
The non-performing loan ratio for all Chinese banks signs that these borrowers are turning to shadow
stood at 1.99 percent at the end of May 2017, down banks as an alternative funding source, which drives in
0.16 percentage points from the same period in 2016. particular, demand for trust loans and entrusted loans.
The more commonly reported NPL ratio for commercial On the issue of wealth management products (WMPs),
banks was 1.74 percent at the end of March, unchanged Moody’s says that the pace of growth of WMPs has begun
from the end of 2016 (Yao). China’s ratio of private non- to slow, as regulatory oversight is enhanced. Previously
financial debt to GDP has now breached 200 percent the fastest growing shadow banking component over
– a quarter above what it was in the U.S. ahead of the the past several years, the slowdown in the growth of
financial crisis in 2008. If all off-balance sheet lending the banks’ outstanding WMPs became more apparent
330
non-traditional players. It can include loans from non- were to be included, the total would be substantially
financial companies as well as investment products. It is higher. Credit continues to flow toward unprofitable
outside the bounds of normal banking regulation, so it projects and unproductive assets that generate little or no
largely goes unregulated.) The agency is also targeting return. Fathom estimates China’s non-performing loans
lending between financial institutions in the interbank problem at close to 30 percent of GDP, over ten times
market. Shadow banks tap interbank funding to add higher than the official estimate. If and when growth falls
leverage to wealth management products in order to below the government’s comfort level, we expect the
offer higher yields. Small- and mid-sized banks, which clampdown on lending to be reversed (Fathom).
rely more heavily on wealth management and interbank
business, are expected to feel the biggest hit from the Moody’s Investors Service says that liquidity in
latest crackdown. The agency’s aggressive moves came China’s financial system is increasingly tightening,
as President Xi Jinping’s anti-corruption campaign as stricter regulatory measures seek to constrain the
shifted focus toward the financial sector. The CBRC is growth of leverage in the country. “At the same time,
targeting complex financial structures in which funds the interconnectedness between mid- and small-sized
circulate between financial assets — offering high yields banks and the shadow banking sector continues to
to investors and generating fee income for lenders — grow, increasing the risk that funding structures could
but do not spur real economic activity by companies become fragile if confronted with a negative liquidity
and households. Banks sell wealth management shock,” says Michael Taylor, a Moody’s Managing
products in partnership with non-bank institutions such Director. In particular, tighter systemic liquidity could
as trusts, securities companies and fund managers. In crystalize the risks inherent in the more complex and
a statement accompanying new policy guidelines, the opaque funding structures used by smaller banks.
CBRC pledged to “thoroughly examine and rectify the These banks are vulnerable to the withdrawal of
problem of transactions with too many participants, wholesale funding, which they have used to finance
complex structures and excessively long chains, which their investments in the trust and asset management
causes funds to ‘take leave of the real and enter the schemes of non-bank financial intermediaries to boost
virtual’.” A key focus of recent policy actions on shadow profitability, as well as to circumvent capital restrictions
banking is to eliminate so-called “regulatory arbitrage” on lending. “The Chinese authorities recognize the risks
between these three agencies. Financial engineers in the shadow banking sector and are seeking to address
have learned to exploit differences between the rules them through a new set of regulatory guidelines,
that govern similar investment products depending on highlighting that preventing financial risks has become
which regulator supervises the institution that issues the one of the government’s top priorities this year,” says
product. Increasingly, wealth management products use George Xu, a Moody’s Associate Analyst. “However,
“nested” structures akin to financial derivatives: a bank there are indications that regulatory measures to curb
may sell one product based on an asset management system-wide leverage show unintended consequences;
plan from a securities company, which is in turn a specifically, in reviving ‘core’ shadow banking activities
derivative of a trust loan. Such complexity makes it that had previously been constrained by regulation,”
virtually impossible for investors to discern the identity adds Xu. Moody’s explains that because of government
of the final borrower or assess default risk. Complexity efforts to constrain the growth of leverage, borrowers
also creates contagion risk because a single default can in sectors such as property, local government financing
inflict losses on multiple institutions with derivative vehicles and overcapacity industries with high financing
exposures (Wildau). needs face reduced access to traditional bank loans and
the primary bond market. As a result, there are increasing
The non-performing loan ratio for all Chinese banks signs that these borrowers are turning to shadow
stood at 1.99 percent at the end of May 2017, down banks as an alternative funding source, which drives in
0.16 percentage points from the same period in 2016. particular, demand for trust loans and entrusted loans.
The more commonly reported NPL ratio for commercial On the issue of wealth management products (WMPs),
banks was 1.74 percent at the end of March, unchanged Moody’s says that the pace of growth of WMPs has begun
from the end of 2016 (Yao). China’s ratio of private non- to slow, as regulatory oversight is enhanced. Previously
financial debt to GDP has now breached 200 percent the fastest growing shadow banking component over
– a quarter above what it was in the U.S. ahead of the the past several years, the slowdown in the growth of
financial crisis in 2008. If all off-balance sheet lending the banks’ outstanding WMPs became more apparent
330
