China’s tighter financial regulations seen having minimal impact on economy
Small and medium banks are most at risk under China’s regulatory tightening, but the broader impact will be modest as Beijing seeks to minimise disruption to the economy, say analysts.
“Lessons learned from the June 13  cash crunch, new policy tools and the policy priorities ahead of the 19th Party Congress all suggest to us that a 2015-like crisis will be averted,” Citi analysts led by Liu Ligang said in a research report issued on Wednesday.
Chinese financial regulators have moved towards tighter oversight since March. The People’s Bank of China (PBOC) has been squeezing interbank liquidity and has pushed for economic deleveraging. The China Banking Regulatory Commission (CBRC) has issued documents and guidance urging banks to implement self-inspection of their asset management businesses and rein in interbank borrowing and off-the-book business transactions.
The China Insurance Regulatory Commission (CIRC) and China Securities Regulatory Commission (CSRC) have respectively published documents and introduced measures stressing tighter supervision and risk control.
The latest regulatory moves, dubbed “competitive regulation” by investors, referring to the intensive and frequent actions taken by regulators in response to the leadership’s call to clear out financial risks, have unnerved China’s real economy as well as its financial markets.
As a consequence, April’s economic data was weaker, commodities have been sold off, money-market rates have surged, bond-market yields are inverted, and the A-share market has slumped.
“Enforcement of tighter regulations, with President Xi’s endorsement, has sent a strong message to the banking system,” the Citi report said.
“Some of the market volatilities and sell-offs witnessed so far could have been driven by the rapid responses of some large financial institutions. In addition, the anti-corruption investigation on the
previous chairman of CIRC will continue to impact insurance funds in the shadow banking space, especially in interbank markets.”
As a result, small and medium sized banks (SMBs) could be hit the hardest, according to Citi analysts.
Official numbers show that SMB balance sheets have grown much faster than those of large banks. From the first quarter of 2015 to third quarter 2016, SMB assets grew 43 per cent to 98.6 trillion yuan (US$14.3 trillion), accounting for 48 per cent of total banking system assets, while asset size at large bank increased only 22 per cent in the same period.
After the rise in interbank lending costs and top-down scrutiny from regulators, “the broad trend is that SMBs will have to start to shrink their intermediary business and focus on their lending to the real economy. The balance sheet contraction could be a painful process in the short term,” Citi analysts said in the report.
Leon Qi, an analyst with Daiwa Capital Markets, said that banks with a weaker capital buffer would face bigger pressure.
Specifically, if the CBRC confirms it will lift risk weightings and require more provisions for non-standard investments (NSIs), banks will face further capital and provision pressure going forward.
“We believe banks holding a larger number of non-standard assets with a high proportion of interbank liabilities and more [certificate of deposits]... would likely see liability cost pressures and asset growth limitations,” he said in a note issued on Monday.
On the macro economic level, analysts with Citi are expecting regulatory tightening to help China’s goal of financial deleveraging and corporate deleveraging, which could improve the economy in the long run.
“Better than expected economic data in recent quarters provides a good window for China to proceed with structural reform initiatives. If dealt with properly, financial deleveraging should reduce rather than increase financial systemic risks,” they wrote in the report.
As for corporate deleveraging, Citi said data suggested China’s corporate credit expansion is at mid-single-digit percentages currently, lower than nominal GDP growth, thus corporate credit-to-GDP ratio improvement continues.
“The current regulatory tightening is no more than a tempest in a teacup for 2017,” said the Citi report.
“But the markets will need to sense the determination of the regulators and top leadership that rampant financial speculation and easy money will no longer be tolerated. In light of China’s willingness to open its financial services and capital markets for foreign participation, this clean-up before opening up is also deemed necessary,” it added.
Similarly, analysts with Nomura said in a note issued on Thursday that they had “become less pessimistic on 2017”.
“We believe the risk of bankruptcy at major financial institutions in 2017 is minimal. The process of deleveraging the shadow banking system will be drawn out, but ultimately well managed,” the note said.