The regulatory pressure on the shadow lending industry in China is easing and could play in the hands of the structured products market but remains a 'systemic risk' for the domestic market, according to Alicia Garcia Herrero (pictured), chief Asia Pacific economist at Natixis.
China’s aggressive crackdown on the shadow banking started in 2017 to curb the rapid growth of banks’ off-balance sheet lending amounting at around US$9 trillion.
The move, however, came with a cost as funds from the industry had been a source of funding for private companies in China for years. With access to the shadow funds cut off and many companies from the private sector going through a credit crunch, the tighter regulation exacerbated the country’s cyclical slowdown last year, said Garcia Herrero.
This inevitably has resulted in China’s policymakers to shift their focus in reviving short-term growth and strengthening investor confidence for structured products in China.
“Although the official shadow banking component – e.g. entrusted loan, trust loans and bank bills of acceptance – is still contracting by 10% YoY in May 2019, we see there is less regulatory pressures from our big data analysis,” said Garcia Herrero. “This is especially true when banks are allowed to set up their wealth management subsidiaries and invest in non-standard assets.”
The China Banking Regulatory Commission (CBRC) laid out new regulations late last year that require commercial banks to set up independent wealth management units. The rules allow products of wealth management subsidiaries to directly invest in stocks and puts an investment cap of 35% of the net assets of wealth management products in non-standard credit assets, or off-balance-sheet loans.
The country’s two largest lenders – Industrial and Commercial Bank of China (ICBC) and China Construction Bank – recently received the green light from regulators to launch wealth management subsidiaries.
A local Chinese banker told SRP the new measure has helped boost off-balance sheet assets, but claimed the products sold are different as they are managed based on their net-asset-value (NAV).
“Switching to NAV basis is a good start, but the challenge is whether the expectation of implicit guarantee can really be removed from markets, not purely moving between new and other products,” said Garcia Herrero. “For now, it’s still difficult to imagine Chinese investors to accept investment losses from high yield products issued by big issuers.”
She added banks are quick in searching for regulatory loopholes, citing the recent surge of structured deposits issuance which already contributes to “6% of their total deposits.”
Investors outside of China have also been piling up into credit-linked structured products, prompting a “pretty ferocious rally” in the Asia credit market.
“Bonds have come back into favor in a very big way as people have gotten a lot more comfortable, especially in the region like Chinese high-yield bonds,” said an Apac head of structured credit trading at a European bank in Hong Kong. “A lot of clients were very wary about the amount of refinancing risk that these companies had last year, but coming in this year, rates are not going up anymore, at the same time, the Chinese government policy has become a lot more accommodating, making it easier for a lot of the companies to raise financing in CNY onshore,” said the banker.
While a relaxed regulatory framework can provide a much-needed breathing room for China to prop up growth alongside fiscal and monetary stimulus measures in the short-term, Garcia Herrero pointed out that the shadow banking sector is a “huge systemic risk” in the long-term.