May 2, 2016 11:23 am
China financial regulator clamps down on shadow banking
Don Weinland in Hong Kong and Gabriel Wildau in Shanghai
China’s banking regulator is cracking down on financial engineering that Chinese banks have used to disguise trillions of dollars in risky loans as investment products.
The clampdown, which will force banks to make provisions they previously avoided by disguising loans as investments, is designed to deflate one of the fastest-growing areas of the vast shadow banking apparatus, where bad debts are increasing.
Shadow banking emerged as a force five years ago, ranging from interbank transactions through to wealth management products, which promise inflated returns often backed by loans to struggling companies.
During the past three years, banks in China have used complex accounting techniques to move loans off the balance sheets and into a category of investments that requires less provisions than loans.
It has also reduced the rate of defaults that appear on bank balance sheets because the assets no longer have the characteristics of loans.
These so-called debt receivables have become one of the fastest growing areas of Chinese banks. Debt receivables increased 63 per cent to Rmb14tn ($2.2tn) last year, according to an analysis of 103 Chinese banks by Wigram Capital Advisors, equivalent to 16.5 per cent of the formal loan book.
Analysts say shadow banking poses a big risk to China’s financial system because many of the products are designed to skirt regulation and promote risk-laden investment.
Under the new rules, released at the weekend by the China Banking Regulatory Commission, banks can no longer use wealth management funds to invest directly or indirectly in their own investment products. The lenders will also have to fully provision for the investment products that are based on bank loans.
“If execution is right, I think you will see a major impact on the banks, especially some of the smaller ones,” said Wei Hou, director at Sanford C Bernstein in Hong Kong. “Some of the small banks could need additional capital.”
While smaller banks are most active in shadow banking, the big four state-owned banks also reduced provisions last year on their traditional loan books. By making less provision, the biggest banks were able to maintain largely flat profit growth last year. If they are forced to provision more for once-hidden losses, profit growth could decline faster this year.
Ratios for provisions on losses continued to fall in the first three months of the year, financial statements showed.
The provisioning ratio at China’s biggest bank,Industrial and Commercial Bank of China, fell to 141 per cent of bad debt, below the 150 per cent threshold set out by the regulator, which was recently lowered from 200 per cent. ICBC’s profit growth was nearly flat for the quarter.
Mid-sized Industrial Bank reported some of the highest levels of investment receivables in its first-quarter results. The bank held Rmb2tn in investment receivables as of the end of March, 36 per cent of its total assets and equivalent to the size of Singapore’s gross domestic product last year.
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