Nothing new in Beijing's latest 'clampdown' on shadow loans
Instead of more edicts, some enforcement of the rules would help, even though the root problem is the mainland's artificially low interest rates
Another year, another clampdown on China's shadow banking system. Last month, the State Council issued a policy directive aimed at tightening the regulation of China's ballooning market in murky off-balance-sheet loans.
The document contained few details, but according to news reports the new measures made it more difficult for banks to exceed lending quotas by shifting loans off their books.
It also banned wealth managers from pooling the proceeds from their sales of structured notes to investors and prohibited the country's trust companies from making loans, ordering them to stick to asset management.
At first glance, this looks like a prudent attempt by the authorities to get a grip on China's opaque and risky market in informal loans.
Beijing's concern is understandable. In the past five years, the value of off-balance-sheet lending has exploded. In the first 11 months of last year, new lending via just three types of shadow loans - loans by trust companies, business to business loans brokered by banks, and loans made through the issuance of leveraged bank acceptance bills - expanded 60 per cent to hit 4.6 trillion yuan (HK$5.8 trillion).
To put that into perspective, these shadow loans made up 30 per cent of all new credit extended in China over the period (see the first chart).
Many of these loans go to local government-backed property and infrastructure projects, often of such dubious merit that the developers would find it tough to access regular bank loans.
According to an audit of local government finances published last week, in June last year these contingent liabilities made up 7 trillion yuan of local governments' 18 trillion yuan debt mountain, up 75 per cent from 2010.
In many cases, banks raise the funding for these loans by selling so-called wealth management products to their depositors (see the second chart). These short-term notes typically offer investors a couple of percentage points in extra yield compared with time deposits. But buyers seldom realise that the vast majority of wealth management products guarantee neither the advertised returns nor even the return of their principal on maturity.
In short, this is a high-risk market, where both its opacity and the rapid speed of its growth only magnify the probability of a nasty train wreck along the lines of the crisis which hit the US shadow banking system in 2008.
No wonder, then, that Beijing says it wants to boost its regulatory oversight of China's off-balance-sheet lending.
However, there's a problem with the directive issued last month: it appears to contain nothing new. In its first-quarter monetary policy report last year, the People's Bank of China detailed the risks shadow banking poses to the regular financial system, and effectively ordered China's banks to bring informal loans back on to their balance sheets by decreeing they should hold adequate capital against their shadow market operations.
Meanwhile, in March last year the China Banking Regulatory Commission issued detailed rules forbidding the pooling of wealth management product proceeds and restricting the scope of trust companies to make loans. In other words, we have heard everything in the latest clampdown before, and in a lot more detail.
Yet enforcement has been patchy at best; banks and trust companies have easily devised ways to circumvent the rules and the shadow market has continued to expand at a breakneck pace.
The reason is straightforward. By setting official interest rates artificially low, Beijing has created enormous demand from savers for yield, and from borrowers for credit. Supply has simply expanded to meet that demand.
Beijing's latest attempt to tighten regulation, though commendable, won't change that.