Across The Border

Beijing may not accept tighter banking regulation if it dents economic growth

The current regulatory frenzy might slow the economy by pushing up borrowing costs and leaving smaller banks short of funds

PUBLISHED : Sunday, 16 April, 2017, 12:07pm
UPDATED : Sunday, 16 April, 2017, 8:59pm

The Chinese banking regulators are currently going through one of their periodic bouts of activity as they look to drive de-leveraging and reduce systemic financial risk.

Few doubt that this is a good thing in the long run, but the question remains whether they will be able to keep up the momentum, should stricter enforcement of the rules lead to a short-term decline in economic activity. That, of course, is a question of politics, and not regulation.

In the first quarter of this year, the China Banking Regulatory Commission (CBRC) imposed fines of 190 million yuan on financial institutions, the regulator revealed last week as it announced a new series of measures to target financial malpractice.

These new measures are by no means unique, and last week the Post reported on forthcoming regulations to tackle so called regulatory arbitrage by Chinese banks, just the latest in a stream of new or tightened rules that have come from the CBRC since the former China Construction Bank (CCB) chairman, Guo Shuqing, took the helm in February.

The question is, ‘will a GDP growth rate of 6 or 5.5 per cent be considered acceptable?’
Katherine Lei, co-head of banks research for Asia ex-Japan, JP Morgan

There has certainly been a string of regulations since Guo took over, even though his organisation has itself come under scrutiny – on Friday, the CBRC’s fifth-highest ranking official Yang Jiacai was reported to be ‘out of contact’.

“Various regulators have issued a series of tightening measures intensively since late March, all targeting the reduction of systemic risk, de-leveraging and enhancing governance,” said Becky Liu head of China macro-strategy at Standard Chartered Bank in a note.

These rules have come on top of a tighter macro prudential assessment at the end of the first quarter, which for the first time included an adjustment to increase the significance of off-balance sheet wealth management products.

The tighter rules are a response to rising concerns about the level of risk in China’s financial system, with the banks’ exposure to wealth management products and other non-standardised assets often seen as a key source of risk, especially for smaller banks.

Some banks have a combined loan book and investments that are greater than their deposit base, forcing them to borrow short-term funds from the interbank market to cover longer duration liabilities. Minsheng Bank, Huishang Bank, and China CITIC bank had adjusted loan-to-deposit ratios in excess of 100 per cent in the first half of 2016, according to JP Morgan’s figures, while Fuzhou-based Industrial Bank had an adjusted ratio approaching 160 per cent.

The People’s Bank of China has already been raising the cost of borrowing in the interbank market, which analysts have seen as an attempt to warn banks away from risky activities.

As such, the attempts to push the banks to acknowledge more of the risk they have on their books must be a good thing, in the long run at least.

In the short term however, banks with messy balance sheets will be forced to pay higher costs to borrow in the interbank market as their larger counterparts begin to worry about the risk of such lending. Banks who have to pay more to borrow themselves would presumably pass on these costs by charging higher rates to corporate customers.

“This will have an impact on the economy, and will lead to more defaults,” said Katherine Lei, co-head of banks research for Asia ex-Japan at JP Morgan.

“The question is, ‘will a GDP growth rate of 6 or 5.5 per cent be considered acceptable?’”

Furthermore, if the regulators require banks to fully acknowledge all risks to which they are exposed, even the ones hidden in off balance sheet liabilities, then a number of the smaller banks may also have insufficient readily available funds to meet their regulatory thresholds.

“The question for the authorities is, ‘are you prepared to recapitalise some banks?’” said Lei.

Such questions then move from the desks of the regulators to those of the policy makers.

A slowdown in economic growth would not be welcome in a year of political transition, though there may come a point where kicking the can down the road is no longer an option.