Across The Border

Shadow banking crackdown to hit smaller banks hardest

Proposed new rules for booming wealth management sector dubbed ‘strictest ever’

PUBLISHED : Monday, 01 August, 2016, 4:57pm
UPDATED : Monday, 01 August, 2016, 10:51pm

China’s banking regulator is set to tighten its control of the wealth management product (WMP) market, as part of the government’s latest efforts to curb ballooning debt levels in the shadow banking sector.

Top of the China Banking Regulatory Commission’s agenda is likely to be drafting new rules to restrict the investment by banks in WMPs, according to state-run Shanghai Securities Journal, quoted sources from CBRC.

The proposals have already been dubbed the “strictest WMP rules ever” by local media, but analysts fear the measures could slow credit growth and put a lot more pressure on the capital and earnings of smaller lenders, key players in the shadow banking market.

“It could put particular pressure on those smaller banks with higher proportions of off-balance sheet assets,” said Qu Qing, an analyst for Hua Chuang Securities.

WMPs are high-interest products that banks offer to customers seeking better returns than deposit rates. But they usually do not appear on a bank’s main balance sheet.

Instead, banks extend the off-the-book assets to trust firms, which then invest the money through various channels, usually carrying higher risk, in exchange for better yields.

However, as banks do not generally withhold reserves for shadow lending, WMPs can be highly risky in the case of loan defaults.

China’s shadow banking activities have been growing at a rapid pace, and off-book lending accounted for approximately 40 per cent of all new credit in the first quarter of 2016, according figures from Deutsche Bank.

By June, Chinese banks had sold 25-26 trillion yuan worth of WMPs, an 8 per cent rise since the beginning of the year, according to other research from China International Capital Corp.

This explosion in the level of such risky loans has sounded alarm bells for the government, which fears a massive credit bubble could threaten the stability of the banking sector.

“Chinese financial regulators are taking a tougher stance against banks accumulating risky assets, ” said Qu from Hua Chuang Securities.

He said the top four regulatory agencies — the People’s Bank of China and the regulatory commissions of the securities, banking, and insurance sectors — recently unveiled various measures to try and control financial risk, “indicating the central government is striving hard to reduce leverage amid mounting debt”.

Under a draft of the banking regulator’s new rules, it is likely banks will not be able to invest their products sold to mass-market clients in riskier equities or “non-standard” assets.

They will also be expected to set aside half of their management fee income as potential impairment provisions for the WMPs against the expected rate of return

And other restrictions could include a 140 per cent cap on the leverage of each WMP.

We expect smaller banks to face higher earnings and capital risks, as they are the key players in the shadow market
Deutsche Bank analysts

Deutsche Bank analysts say the new rules should help reduce longer-term credit risk , but shorter term they add, too, the prohibitions could “severely” affect smaller players, particularly.

“We expect smaller banks to face higher earnings and capital risks, as they are the key players in the shadow market,” they said.

According to Deutsche estimates, WMPs accounted for 15 per cent of the Chinese banking sector’s total assets last year, but some individual cases show much higher exposure to the class.

China Everbright Bank’s WMP balance reached 39 per cent of its total assets, while China Merchants Bank had a 33 per cent reading. Ping An Bank, Industrial Bank and China Minsheng Bank also had shares of 30, 27 and 23 per cent, respectively.

In contrast, ICBC, Agricultural Bank of China, China Construction Bank, and Bank of China, the country’s so-called Big Four state-owned banks, had readings of less than 15 per cent.

Deutsche Bank has given a ‘Sell’ rating to the A-shares of China Citic Bank, China Minsheng Bank, Shanghai Pudong Bank, and Industrial Bank in its report.

It rated ICBC and China Construction Bank a ‘Buy’, while offering a ‘Hold’ rating on Bank of China and Agricultural Bank of China.

That said, the magnitude of the potential impact largely depends on whether the new rules apply only to the incremental issuance of WMPs, or the outstanding value of China’s WMPs, Deutsche Bank analysts added.