China’s shadow banking crackdown shakes markets

A crackdown on China’s $9.4tn shadow banking business is hitting bank share prices and rattling bond markets.

The country’s new top banking regulator has already taken several shots at stemming the rapid growth of off-balance-sheet lending at banks since taking control in February. The central bank has also tightened liquidity in the financial system, sparking angst earlier this year.

A flurry of rules to discourage banks from using borrowed money to invest in bonds have been issued by the regulator. The sell-off that has followed has pushed bond yields to two-year highs and even led to a rarely seen inversion of the yield curve.

The moves have also dented the share prices of Chinese banks — among the world’s largest by market capitalisation — wiping out about $38bn in shareholder value in a two-month stretch.

“It’s been very clear . . . that regulators want to stamp out some of this [shadow banking] activity,” says the Asia head of a securities unit at a global bank. “During that time there’s been lots of inquiries from investors and some concern on what that will look like.”

The CSI 300 bank index fell nearly 10 per cent in the weeks after Guo Shuqing, a respected Beijing technocrat, was appointed to the head of the China Banking Regulatory Commission (CBRC) in February, although it has recovered somewhat following a central bank liquidity injection in early May.

Individual stocks of lenders known to engage heavily in shadow banking, such as China Everbright Bank and China Minsheng Bank, have suffered during the period.

Shadow banking expanded by about 20 per cent in 2016 to Rmb64.5tn, following several years of much higher growth, according to rating agency Moody’s. While expansion of the industry plateaued at the end of last year, the first quarter of 2017 witnessed a resurgence in entrusted loans and trust products, two pillar instruments used in shadow banking. In an unexpected move last week, Moody’s cut China’s credit rating for the first time in 25 years, due to economic and financial risks.

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The curbs to shadow lending are part of a much larger shift in how president Xi Jinping controls China’s financial sector, says Kevin Lai, chief economist for Asia ex-Japan at Daiwa Capital Markets.

Mr Xi has been working to uproot imbalances in the financial system that have allowed some individuals to grow extremely wealthy, Mr Lai says.

Those changes include the departure of Shang Fulin as CBRC head and replacing him with Mr Guo, followed by putting the head of China’s insurance regulator, Xiang Junbo, under investigation in early April. Wealth management sold through insurance groups have also been curbed. The leaders of China’s top three financial regulators are now Xi appointees.

Rules issued by the CBRC in May will force banks to be more transparent about wealth management products, which are often channelled to borrowers through asset management companies or trusts.

Rumours that Mr Guo may unleash a sweeping campaign to clean up the channels that are used to structure products, namely asset managers, have been rocking markets, says Xia Le, chief economist for Asia at BBVA.

Several large banks have started to restrain standard long-term lending in preparation for reforms that could require extra liquidity, he says.

“I’m aware of some bank managers that have stopped giving longer-term loans because they think there is a possibility they will need to move off-balance-sheet loans on to the balance sheet — a type of bail-in that could require lots of capital,” Mr Xia says. “Asset managers and trust companies are already starting to unwind some of their businesses.”

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Wealth management products have been exceptionally popular for years among banks and their customers. The products have given banks a loosely regulated and highly lucrative channel for using funds that would otherwise be simple deposits.

Because the instruments are off balance sheet, institutions can use them to ramp up their lending. New credit hit a record high in January, mostly due to lending by non-bank institutions.

For customers, wealth management products promise far higher returns than artificially low rates on deposits but with an implicit guarantee from government-backed banks.

Foresea Life Insurance, one of China’s biggest insurers, this month said that it expected Rmb60bn ($8.7bn) in redemptions in wealth management products this year, and warned of the possibility of mass defaults and social unrest. But China’s central bank is waging an ongoing battle to rein in issuance of these instruments, out of concern that a rise in defaults would create panic, and possibly destabilise the banking system. The rest of the world is watching.