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Tighter Liquidity, Stricter Regulatory Scrutiny to Dampen China’s Shadow Banking Activity, Moody’s says

By Han Yi and Dong Tongjian

(Beijing) — A combination of tighter liquidity and stricter regulatory scrutiny on commercial lenders’ off-balance sheet activities will dampen fast-growing shadow banking activity in China, a recent report by Moody’s says.

Broad shadow banking assets, including entrusted loans, financing through trust companies, undiscounted bankers’ acceptances, and wealth management products (WMPs) reached 58 trillion yuan ($8.42 trillion) in the first half of 2016, equivalent to 82% of gross domestic product, according to the recent report released by Moody’s Investor Service.

 

UBS AG, the Zurich-based global financial services company, estimated that the size of credit loans offered through shadow banking was about 60 trillion to 70 trillion yuan as of the end of last year, accounting for 33% of credit lending, up from 10% a decade ago.

The shadow banking business is still growing. The Industrial and Commercial Bank of China (ICBC), the world’s largest bank by total assets, plans to issue additional WMPs worth 250 billion yuan in the first quarter of 2017, said employees of the state-owned lender. At the start of this year, ICBC managed 1.68 trillion yuan through WMPs.

While big banks are net fund suppliers in the interbank market, small and midsize banks, securities firms, and other financial institutions are net borrowers, the Moody’s report said. It pointed out that smaller banks rely heavily on wholesale funding, including aggressive issuance of certificates of deposit, and the purchase of WMPs in the interbank market as a way to boost profits amid declining net interest margins.

“Small and midsize banks are active investors in shadow banking products, including other banks’ WMPs, the trust and asset management plans of non-bank financial institutions,” the Moody’s report said. A growing reliance on wholesale funding exposes smaller banks to possible liquidity shocks caused by the withdrawal of funds by other financial institutions, especially when demand for cash increases at the end of the year or if default scandals occur, which in turn prompts the smaller banks to call back their own funds.

The growth of shadow banking may slow as regulation becomes more stringent, which mainly targets off-balance sheet WMPs, said Xu Jing, an assistant analyst with Moody’s Investor Service. In December, China’s central bank confirmed that it would include banks’ off-balance sheet WMP business in the Macro Prudential Assessment framework, a system to monitor commercial lenders’ credit exposure.

Contact reporter Dong Tongjian (tongjiandong@caixin.com)

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