China's clampdown on shadow banking begins to bite
The mainland's clampdown on the lending market is beginning to bite as interest rates rise sharply, funds dwindle and default worries mount
Jasper Moiseiwitsch, Langi Chiang and Jane Cai
Tom Liu, a cement plant owner in Jiangsu province, borrowed five million yuan (HK$6.4 million) earlier this month. The six-month loan was to upgrade production lines.
"I'm really lucky to have secured the loan. It's extremely hard to obtain credit these days," Liu said.
His case points to an unfortunate and unintended consequence of the central government's clampdown on shadow banking.
As official pressure builds, the market is fraying at its edges, and this is pushing up funding costs for the small to medium-sized firms that depend on access to such capital.
Bank of America Merrill Lynch last week said yields on wealth management products were at a record high.
Interbank lending rates rose sharply again last week. On Friday, the seven-day repo rate climbed above 7 per cent from 4.35 per cent on Thursday.
Trust companies source their funds through the interbank market. The fact the interbank market is prone to regular credit squeezes suggests a key financing channel underpinning the shadow banking sector is becoming less viable.
But most alarmingly is the possibility of a default of a three billion yuan wealth management product at the end of the month. The firm backing the instrument, Zhenfu Energy, a coal miner, has gone bust.
Industrial and Commercial Bank of China, which distributed the product, has said it will not bail out investors. Investors hope underwriter China Credit Trust will repay them.
The media has been reporting possible defaults of trust sector products, any of which could unwind this sector, meaning small and medium-sized enterprises would find it difficult to refinance maturing trust loans.
"A default would make it difficult for other borrowers to continue to roll over their debt. So there's a contagion risk for the rest of the trust sector," said Zhang Zhiwei, a Nomura economist.
There are indeed early signs that small and medium-sized firms are getting squeezed.
Liu pays an annualised 15 per cent interest for the half-year loan, using his 20 million yuan shareholding in his cement plant as collateral.
"The interest rate was not abnormally high, but the five-day scrutiny before the loan approval was meticulous," he said.
Apart from the operation status of his plant, his partners, colleagues and friends were asked intensively about his personal life. "The questions included whether I have ever gambled in Macau, if I have a mistress and my track record as a borrower," Liu said. "It was completely different with the experience I had three years ago, when I borrowed five million yuan from another microcredit firm. I was only asked to show my business licence and no collateral was required."
Nie Yuzhen, who sells jewellery and accessories in Yiwu county, Zhejiang province, said interest rates in the shadow banking sector soared to 50 per cent from 15 per cent after the State Council last month issued a warning about the sector.
"Interest rates surged as many private lenders shrank or even halted business," Nie said. "I'd rather cut procurement than borrowing."
The shadow banking market can be broadly defined as lending to firms outside the traditional banking sector. Such loans are generally off the balance sheets.
In its widest sense, shadow banking involves a vast range of credit creation, including peer-to-peer online lending, pawn shops, microcredit lending and loans to local government funding vehicles.
Trust companies, which are lightly regulated, all-purpose financing entities, lend to firms cut off from bank loans. They then work with banks to package these debts as wealth management products: short-term securities that pay moderately higher yields than bank deposits. A typical wealth management product yields about 6 per cent, while a one-year term deposit pays about 3 per cent.
Investors have yet to lose money on their trust investments. They believe the banks and trust firms that create and sell the instruments ultimately back the product - even though they make no such guarantees.
Betty Zhang, a Beijing lawyer, in October invested in a wealth management product issued by a trust firm. She pooled her funds with her friends for the minimum investment of 10 million yuan.
The instrument invested in an engineering project. It had a two-year maturity and Zhang was told it would yield 10 per cent per annum, even though regulators prohibit trust firms from promising guaranteed returns. Zhang was indifferent to the creditworthiness of the party ultimately borrowing the money.
"I don't care where the fund is invested," she said. "I haven't even looked at the relevant documents carefully. I trust the trust company. It's very reputable."
Regulators are ambivalent about the shadow banking market. The State Council last month issued a circular calling for more regulation of this market. But it also said shadow banking was a "beneficial" and "inevitable" market development.
"The large part of this reason the parallel market (shadow banking) exists is because the government cannot let go of its growth targets. If we see an economic slowdown, will the government continue to pull back on the parallel market, which is an important source of investment?" said Dorris Chen, the head of China financials research at Standard Chartered.
The hope is that the government would slowly roll back the market, to keep it viable while containing some of its excesses.
Analysts talk of deleveraging that is under way.
Fitch estimates that total credit will drop slightly this year, largely thanks to regulators' clampdown on trust loans and the wealth management products that back them.
The impact for firms outside the China' formal banking market is clear: higher funding costs.