China’s shadow banking system continues to expand at a torrid clip amid strong demand for credit, with assets held by these less-regulated lenders equivalent to 78 per cent of annual economic output at the start of the year, according to Moody’s Investors Service. The credit rating agency’s July Shadow Banking Monitor report, showed credit growth – as measured by total social financing (TSF) – rose 11 percentage points in the first half of 2016 to 217 per cent at the end of June, outpacing nominal GDP. “The increasing size of the shadow banking system means that during a disorderly contraction, banks could have difficulty replacing shadow banking credit, leaving borrowers who rely on such financing at risk of a credit crunch,” Moody’s said. However, the report also said that TSF, in its measurement of credit growth in the financial system, fails to capture up to one-third of shadow banking activity. In particular, TSF misses fast growing shadow banking segments such as assets funded by wealth management products (WMPs), which accounted for 40 per cent of the stock of shadow banking finance as of end-2015, and which nearly doubled as a share of banking assets to 11 per cent. Those components of shadow banking that are not directly included in total social financing have expanded rapidly, to comprise 59 per cent of total shadow banking at the end of 2015, up from 40 per cent at the end of 2012. “We estimate the difference between broad shadow banking and the portion captured by TSF, which is growing, to be at least 16 trillion yuan at end-2015 (23 per cent of GDP), or 30 per cent of total shadow banking,” the report said. Assets under management by non-bank financial institutions have increased Moody’s report Over the past few years, shadow banking has become sizeable as a share of bank loans and total bank assets given its rapid growth, according to research from Moody’s. “We estimate that shadow banking assets grew by 30 per cent in 2015, reaching almost 54 trillion yuan at end-year, equivalent to 78 per cent of GDP,” said the Moody’s report. Furthermore, China’s shadow banking market is highly interconnected with the formal banking sector, due to continued growth of banks’ investment receivables and the relative magnitude of the various financing channels, resulting in increasing spillover risks to banks. Stephen Schwartz, a senior vice president at Moody’s, warned that as a result, “the rise in overall leverage and further expansion of shadow banking activity are pushing up financial risks”. According to Moody’s, banks could have difficulty replacing shadow banking credit during a disorderly contraction, leaving borrowers who rely on such financing at risk of a credit crunch. In addition, e-finance and FinTech companies in China are expanding rapidly, benefitting from opportunities afforded by an under-developed consumer banking system. On the other hand, Moody’s also indicated that tighter regulations on off-balance sheet lending by banks has led to a sharp decline in undiscounted bankers’ acceptances as well as sluggish growth of trust loans. Most recently, the China Securities Regulatory Commission (CSRC) issued rules to curb leverage of investments in the bond market by setting a cap on the financing ratios of structured asset management plans that invest in bonds. In May, the China Banking Regulatory Commission (CBRC) also issued guidance on banks’ loan-beneficiary rights transfers, to curb the practise of banks transferring loans off balance sheet without full risk transfer, and to enhance transparency of non-performing loans on their books.