Watchdog warns on hidden lending

PUBLISHED : Saturday, 14 January, 2012, 12:00am
UPDATED : Saturday, 14 January, 2012, 12:00am


China's banking watchdog has warned trust companies to stop selling investments backed by banks' so-called discounted bills.

It is one of the latest moves aimed at monitoring lenders' off-balance-sheet risks, according to people familiar with the matter.

Banks have been working with trust firms to sell investments that have discounted bills as underlying assets, as a means to free up banks' loan books. The problem, analysts say, is that the practice circumvents Beijing's efforts to monitor and control growth of credit and essentially disguises risks banks are taking.

For the past few years, companies that have experienced challenges in obtaining bank loans have often used 'discounted bills' and 'acceptances' to obtain money from banks.

The financial instruments occupy an arcane corner of the financial world. When two companies enter a trade, the seller usually will require the buyer to obtain an acceptance from its bank. The acceptance is essentially a guarantee for future payment backed by the bank. Once the selling party receives the acceptance, it has the option to cash it at any bank at a discount to face value.

For example, if the acceptance is 100 yuan, the company may turn it in and receive 95 yuan from a bank. When this happens, the bank discounting the acceptance records the transaction in its loan portfolio as a 'discounted-bill claim' on the bank issuing the acceptance, which is an off-balance-sheet item.

Acceptances have in recent years turned into a means for banks to obtain deposits, as banks usually require companies to deposit as least 30 per cent of the acceptance in cash or other forms of liquid collateral when applying for acceptances, analysts said. Companies that faced difficulties in obtaining loans could then cash in their 'acceptances' at a discount rate to obtain liquidity.

'The risk of this practice is that it distorts credit growth,' said Sheng Nan, a senior analyst at CCB International, a China Construction Bank subsidiary. 'Essentially, the China Banking Regulatory Commission is trying to let banks grant loans to companies through on-balance-sheet channels rather than off-balance-sheet channels.'

Fan Jie, an analyst at private research provider Chengdu Benefit, which specialises in wealth management products, said: 'This hasn't been an official notice, but rather just a warning. So I think it's very hard to completely crack down on trust funds selling such products.'

One trust-firm employee said her trust was planning to make discounted-bill-related products a key driver for business this year. She said it usually took some time for banking regulatory policies to trickle down, so they still had 'breathing time'.

Analysts said the warnings, if implemented, would affect banks' loan growth and impact the ability of small- and medium-sized firms to obtain liquidity from banks through non-formal lending channels.

The amount of acceptances more than doubled to 6.5 trillion yuan (HK$8 trillion) by the third quarter last year from 2009. Discounted bills reached 1.49 trillion yuan by the end of September, according to Michael Werner, a senior analyst at Sanford C. Bernstein & Co.