Tag Archives: shadow banking

China’s Regulators Will Squeeze, Not Crush Fintech

CHINA’S TWIN CRACKDOWNS on shadow banking and fintech are aimed, in part, at protecting the country’s staid state-controlled banks and, in part, at reining in a sector of the economy that is growing too fast and too powerful for authorities liking.

Fintech platforms and online payments have attracted many depositors and borrowers dissatisfied with the low interest rates and limited access to credit for non-state borrowers within the state-controlled banking sector. This is draining liquidity from state-controlled banks.

It also deepens authorities’ concerns about the extent to which the tech giants are expanding their influence over every aspect of life and about the vast amounts of data they amass from providing services from online payments to shopping, chatting and ride-hailing.

The summoning of 13 tech companies by financial regulators last Thursday, including Tencent, which is the largest shareholder in the online bank WeBank (seen above), to inform them of a raft of new compliance requirements for their fintech businesses, signals that regulators are expanding their campaign to rein in the tech giants’ drive into the financial sector.

Yet it is only the latest example of official pushback. Previous measures include the cancellation of the planned public offering by Alibaba’s fintech spin-off, Ant Group, which was followed by antitrust actions that resulted in a ‘rectification plan‘ to correct unfair competition practices in its payment business, broke down its information monopoly and required it to apply to become a financial holding company. The newly summoned 13 are being given the same treatment.

Even before all that, authorities had instituted a de facto ban on peer-to-peer lending platforms. Indeed, the crackdown on shadow banking dates back to 2016 when concerns about the need to deleverage the economy started to take hold among policymakers.

Further regulation and investigations of fintech businesses will likely continue. However, demand for and supply of alternative finance is unlikely to disappear, and the state-controlled banks are unlikely to meet it any time soon. Their legacy modus operandi as policy agencies rather than independent financial services providers is a heavy one to cast off. Until they do, innovative fintech alternatives will find a way to emerge.

The catch-22 for authorities is that non-bank finance will remain crucial for the private sector, which, in turn, supports much of China’s economic growth and jobs. Thus non-state borrowers are likely to continue to be allowed access to non-bank credit and the tech giants to provide it through their fintech platforms, but both sets will need to be sensitive to the fact that that will increasingly be on authorities’ terms, not theirs, and that those terms may change unexpectedly.

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China’s Debt Hits Close To Home

THIS BYSTANDER HAS been far from alone in highlighting the tightrope that China’s policymakers have to walk between stimulating growth and accumulating more debt as they manage the structural slow down of an economy switching from industrial to services-led growth and facing adverse demographic changes.

Thanks in  part to the People’s Bank of China (PBOC)’s counsel of restraint, driven by the central bank’s twin concerns of the debt bubble bursting and inflation getting out of hand and its measured but steadfast drive for financial sector liberalisation, Beijing has been selective in its stimulus measures to keep a slowing economy expanding at a sufficient pace to hit the official 6% GDP growth target for this year and the larger one of doubling total and per capita GDP between 2010 and 2020.

While the plan has always been to manage a slowing of the economy as it rebalances towards a more sustainable long-term growth model, the impact of the trade and technology disputes with the United States on world trade have put at risk the 5.5-6.0% growth China needs to achieve in 2020 to hit the overarching decade-long goal.

Earlier this month, the central bank cut its lending rates for the first time in three years. The cuts were a token five basis points for the five-year, one-year and seven-day loan rates. There remains plenty of headroom for further monetary stimulus, but not the appetite, on the central bank’s part at least, to occupy it.

Taking a barb at the United States, PBOC Governor Yi Gang said in September that “unlike central banks of some other countries, we are in no hurry to resort to a considerable interest rate reduction or QE policy”. Yi is keeping his powder dry, in the event that significant rate cuts do become necessary to provide monetary stimulus. Yet his priority is to deleverage the economy, or at least in current circumstances to maintain a “stable leverage ratio…to ensure the debt sustainability of the entire society”, as he put it at the same press conference.

In its latest annual financial stability report released this week, the PBOC gave a stark warning about the potential systemic risk in the buildup of household debt, whose total now equals total household income. One figure that caught this Bystander’s eye was the central bank saying that household leverage had hit 60.4% of GDP at the end of 2018. The Bank for International Settlements had pegged the ratio at 54% (four percentage points higher than in the EU, by way of comparison).

The PBOC is particularly concerned about the growth of mortgages and consumer loans. It has warned previously of the buildup of corporate and local-government debt, but turning its spotlight on household debt is a notable change of focus. Easing of mortgage lending standards to boost property investment and the use of consumer credit to increase retail sales have been the main stimuli of growth in recent years. Rising household incomes make the rise in consumer loans manageable for now, although further buildups would test that assumption, especially among low-income households.

A new IMF working paper on China’s household debt notes that

High household indebtedness could constrain future consumption growth and increase financial stability risks…we find that low-income households are most vulnerable to adverse income shocks which could lead to significant defaults. Containing these risks would call for a strengthening of systemic risk assessment and macroprudential policies of the household sector. Other policies include improving the credit registry system and establishing a well-functioning personal insolvency framework.

Regardless, further consumer-focused fiscal stimulus is likely, perhaps a second income tax to follow last year’s 420 billion yuan ($59 billion) one, and the reintroduction of subsidies for electric and hybrid vehicles.

It is the rise in mortgage loans that more concerns PBOC policymakers. Mortgages account for more than half of all consumer debt. There is evidence that they are inflating a speculative bubble, as well a making affordable housing a politically sensitive issue. Nearly two-thirds of outstanding mortgage debt is accounted for by families owning at least two properties. Some of last year’s tax cut has gone into savings rather than retail consumption, with the saving being in the form of property investment.

This all comes against the background of the crackdown on shadow banking, which included unlicensed digital-payments businesses, online lending and other internet finance companies, in the process shutting down all cryptocurrency trading platforms and more than two-thirds of online peer-to-peer lending platforms.

This has split over into the formal banking sector. Three regional banks, Baoshang Bank, Hengfeng Bank and the Bank of Jinzhou, have needed bailouts this year. Up to 30 more have been late in filing financial accounts required by regulators, suggesting further bailouts to come. In addition, corporate bond defaults this year will likely exceed last year’s record.

The ‘big-four’ state-banks are financially robust enough that any such losses can be absorbed without systemic risk. However, having spent several years engineering higher bank asset quality and lending standards, the PBOC will not want to put the big banks in the position of having to underwrite other institutions’ bad debts. Yi has been clear that any can carrying at a troubled financial institution should be done by its shareholders, not the state via the big-four banks.

Part of the exercise in risk management will require financial-markets reform and further opening to foreign investors. China has moved steadily but cautiously on that. The addition of Chinese stocks to MSCI’s benchmark indices and the likelihood that other index providers will follow suit, adds new urgency.

The changes will bring an inflow of foreign capital into Chinese equities of at least $40 billion this year and, on best guesses, a further $30 billion in 2020. That will provide a welcome influx of capital, particularly for companies in the private sector. It will also offer some relief for a central government whose consolidated deficit, the IMF forecasts, will grow to 6.1% of GDP this year and next, from 4.8% of GDP in 2018. As the late US banker Walter Wriston famously said, “capital will go where it is wanted, and stay where it is well-treated.”

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China’s P2P Lenders Are Failing At An Accelerating Pace

REGARDLESS OF MEASURES to ease credit markets to offset any slowing of GDP growth, authorities continue to crack down on the more risky parts of the financial system.

Few pieces of it are as hazardous and ill-regulated as peer-to-peer (P2P) lending.

China has the world’s largest P2P lending industry, worth approaching $200 billion (assets, i.e. loans outstanding) flowing through (now) some 2,000 platforms with 50 million registered users.

The ranks of the P2P platforms are thinning fast, as individual operations fail — some 80 in June (a then monthly record) and around a further 120 so far this month, taking the cumulative number of failures since 2013 above 4,000 according to the Yingcan Group, a Shanghai-based research firm that tracks P2P finance.

Savers are pulling their money from many of the remainder and investors have little confidence many will survive, both factors compounding the accelerating pace of failures. Meanwhile, authorities will be worried about the pick up in the pace of failures over the past week.

Their challenge is to stop a so-far contained panic spilling over into other parts of the $10 trillion shadow banking industry and thence into the main financial system.

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Lending Edging Out Of The Shadows

DOWN IN THE detail of the monthly monetary aggregates for March released earlier this week is the curious point that the M2 measure of money supply slowed its growth even as new bank lending appeared to speed up.

M2 rose 11.6% year-on-year in March, down from February’s 12.5%. New bank lending in the first quarter, at 3.61 trillion yuan ($582 billion), was up 20% year-on-year.

With our usual caveats about reading too much into one month’s figures and making apples and oranges comparisons, it does seem that a large increase in lending hasn’t translated into economic activity in the real economy. Even allowing for the slowing of the economy, it looks as if intermediary credit is being rolled into the banking system — or to put it another way, out of shadow banking and into the (hopefully) cleansing light of the formal banking sector.

Given the warning contained in the IMF’s latest World Economic Outlook published earlier in the week that shadow banking was one of the main vulnerabilities of China’s economy —a warning repeated in the Fund’s Global Financial Stability Report, which said curtailing the riskiest parts of shadow banking should be China’s overall financial stability priority — and the central bank’s long standing concerns about the systemic risk that the $3.2 trillion sector poses to financial system, that is to be welcomed.


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China’s Debt Trifecta: Property Loans, Muni Debt and Shadow Banking

REAL ESTATE AND shadow banking has driven a quadrupling of China’s debt since 2007, the year when the bursting of a global credit bubble brought the world’s financial system to its knees. Since then China’s total debt has risen to $28 trillion (as of mid-2014) from $7 trillion. As a share of GDP, it is now 282% — larger than the comparable figure for developed economies like the U.S., Canada, Australia and Germany.

One would expect China’s total debt to have increased as its economy grew. Though slowing it has still been growing at more than 7% a year since 2007 let us not forget. But the increase in the country’s debt-to-GDP ratio, from 158% in 2007, shows the country has been piling up debt far faster than its GDP growth rate alone would suggest.

Even that relatively high level of debt is still manageable, in the sense that “China’s government has the capacity to bail out the financial sector should a property-related debt crisis develop,” the McKinsey Global Institute (MGI) says in a new report on global debt and deleveraging. The report covers well-trodden ground, but it still provides a sobering reminder. Seven years of the world’s great and good espousing the virtues of austerity have resulted in a $57 trillion increase in global debt outstanding.

China has accounted for one-third of that growth, and, this Bystander notes, is bucking the trend of the debt burden moving from the private to the public sector, where is relatively less systemically risky. Non-financial corporations have been the bigger driver of this increase in China’s debt; the country now has one of the highest levels of corporate debt, at 125% of GDP (U.S. 67%; Germany 54%, by way of comparison).

MGI is relatively sanguine about the big-picture consequences, but it still sees three potentially worrisome developments, all of which will be familiar to regular readers here:

  • half of all loans (excluding financial-sector debt) are linked, directly or indirectly, to China’s cooling but still inflated real-estate market;
  • unregulated shadow banking accounts for nearly one-half of new lending and one-third of outstanding debt; and
  • the debt of many local governments is probably unsustainable; with the $1.7 trillion in outstanding loans to local governments’ off-balance-sheet special financing vehicles the particular worry.

History teaches us — repeatedly — that financial crises often follow rapid debt growth. The most plausible route to that happening in China is that overextended property market meets local government debt bomb. A wave of loan defaults is set off, particularly among the country’s many small property developers (who number into the high tens of thousands). That then ripples through the construction industry, and the city commercial banks and other small lenders that finance developers and building firms.

A government bailout would limit the damage, as it did when Beijing bailed out the big state-owned banks more than a decade ago. But the economy would likely slow dramatically with consequential social unrest and other political implications that the Party just won’t entertain. “The question today,” MGI says, “is whether China will avoid this path and reduce credit growth in time, without unduly harming economic growth.”

MGI’s prescription is conventional: more of what Beijing is already doing, but with greater urgency. That means:

  • reforming municipal finance (allowing local taxation to be raised, deepening the nascent muni-bond market);
  • improving transparency and risk management among lenders (including corporations that are making loans through the shadow banking system);
  • more robust data on real estate markets;
  • improved bankruptcy procedures; and
  • new retail savings and investment products from mainstream financial institutions that can be an alternative to those offered by real estate developers and informal lenders in the shadows and on the curb.

Will all those things happen? Eventually. Such reforms have the backing of the top leadership because the risks of not implementing them are greater than those of doing so — and the latter set are considerable to a Party trying to pull off the unprecedented feat of retaining a monopoly on political power while ceding its monopoly on economic power.

However, it is widely if, not universally accepted that present arrangements are unsustainable. Unwinding them requires time. First, to deal with vested interests that will lose out. China’s are uncommonly thorny because they mostly get their economic interests because they are politically powerful (elite families), rather than drawing their political clout from their economic success.

Second, to phase in the changes so that the cure is not worse than the disease. Just as China has learned from Japan about the importance of managing its currency, so it has learned from Russia the need to avoid a rapid grafting of free-market capitalism onto a socialist economy.

The question is not, does China have too much debt. The question is can the Party buy itself enough time to create the conditions in which the country’s debt is sustainable?

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Trust Defaults Creep Ever Closer To China’s Shadow Banks

THE EXEMPLARY DEFAULT of a high-yielding wealth management product was always going to have to be carefully managed. The default would have to be painful enough to instruct Chinese investors that their assumption that high-yielding investments sold through state banks carry an implicit guarantee is misplaced, but not so painful that it put the shadow banking system at any sort of systemic risk that could ripple through to the mainstream financial system. With China’s trust assets increasing 46% last year to a record 10.9 trillion yuan ($1.8 trillion), it could potentially be a powerful ripple.

But the best laid plans of man, and all that…

With China Credit dodging the bullet, what appears to be the trust company fated to play the fall guy, Jilin Province Trust Co. Ltd, sold a number of high-yielding trust products through China Construction Bank, the funds raised going to a now delinquent coal company, Shanxi Liansheng Energy. Last week, state media reported that Jilin Trust had failed to pay off 763 million yuan of maturing high-yield investments it sold to China Construction Bank clients. It now appears that, according to the official China Securities News, it is just one of six trust companies who lent a total of 5 billion yuan to Shanxi Liansheng.

The concern is that their exposure could trigger similar defaults, and what was intended to be an orderly default, turns into something altogether more panicky within the shadow banking system. Beyond the inherent undesirability of that, it  would put the big state-owned banks in an awkward position. They are not under a legal obligation to repay investors who bought trust products through them, but they may feel a need to do so — or be made to feel a need to do so — in order to maintain their reputations (if the pressure is from below) and uphold social stability (from above).

For now, it seems that provincial officials are working on a debt restructuring for Shanxi Liansheng to forestall things getting out of hand. The coal company was said last year to owe as much as 30 billion yuan. The restructuring discussions involve not just creditors but also the trust companies and the state owned banks. This Bystander suspects the banks will end up extending new loans to the coal company that can be used to pay off the trusts. Not at all the lesson intended. If anything, quite the reverse.


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Another Troubled Trust; Another Default Dodged

THIS MIGHT HAVE been the day that China saw its first high-profile trust default, but a bailout of China Credit Trust averted that undesired outcome. Under a last-minute deal struck this week, the 700 private investors in the three-year high-yield 3-billion-yuan ($500 million) trust will get their capital back but forego the final year of interest payments that remain unpaid.

This Bystander noted previously that how the potential default was resolved — whether by allowing a quick and orderly default, or by shoving it under the carpet via a provincial government bailout — would be an indication of how well the ticking time bomb of local government debt tied to the shadow banking system and its wealth management products is likely to be defused. In the event, it seems that the corner of a carpet was lifted amidst the last-minute negotiations between provincial officials and the financial institutions involved. These included the Industrial and Commercial Bank of China through whose private banking arm the product was sold, but which had said it wouldn’t stand behind the troubled loan.

A mysterious third party has acquired both the investors’ trust rights and the shares in the now defunct mining company that the trust funded, Zhenfu Energy, that had been held as collateral. This is what has let the trust pay off its 700 investors. One local press report says the unnamed white knight was backed by the state investment fund Citic. Meanwhile, Zhenfu Energy has unexpectedly got its mining license back from the Shanxi provincial government and will restart operations.

Economists at the Japanese securities firm Nomura say they have counted 28 similar deflected defaults since 2012. The evil but necessary day when a troubled Chinese wealth management product is allowed to default to show investors the real risks of such investments remains in the future. But how far in the future?


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Trust Loan Teeters On The Edge Of A First Default

A CANARY IN the coal mine: a high-yield investment trust that funded a Shanxi coal mine, Zhenfu Energy, that has gone bust is at risk of default. The three-year $500 million loan was marketed to wealthy individuals, who were promised a 10% yield by issuer China Credit Trust. The trust loan was sold in 2010 through the private banking arm of Industrial & Commercial Bank of China (ICBC), one of China’s Big Four banks. ICBC has said it won’t stand behind the loan, prompting a seemingly angry response from investors.

The trust represents a slither of the $1.2 trillion trust market. Yet how the potential default is resolved — whether by allowing a quick and orderly default, or by shoving it under the carpet via a provincial government bailout — will be an indication of how well the ticking time bomb of local government debt tied to the shadow banking system will be defused.

So far no trust loans have defaulted, despite trusts being bigger by assets than the insurance industry. That is partly because they have become a significant alternative to bank lending for funding local government infrastructure projects so have had friends in the right places to maintain the veneer of wholeness so far. Investors also have had a blind faith that trusts’ issuers offer an implicit ironclad guarantee that investors will get their money back.

There is $16.5 billion of trust loans to mining companies falling due this year. Beyond the case of Zhenfu Energy, at least two other trust loans to coal mines are reportedly in similar straits. A trust loan that funded a Chengdu housing development is also said to be in trouble.

The government, long concerned by the potential instability and credit risk lurking in the shadow banking system, is looking at ways to bring it into the mainstream. It was a regulatory priority agreed at the Party’s Third Plenum last November. Draft regulations being circulated suggest the approach will be to bring the informal banking sector under greater monitoring and regulation rather than curb the lending function that it is fulfilling for capital-hungry small and medium-size businesses that the mainstream banks  do not. The recently announced plan for a pilot scheme for five new privately owned banks is one step in this direction.

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Bringing China’s Shadow Banking More Into The Light

This Bystander has noted before the growing concerns among policymakers in Beijing about China’s shadow banking system, the unregulated credit flows that have thrived beyond the formal restrictions on bank loans. This has quadrupled in size since 2008; at $3.2 trillion it is equivalent to 40% of China’s GDP.

Central bank officials have become increasingly fearful that it poses a potential systemic risk to financial stability. So now it is being reined in, according to a report in the Financial Times. Banks will reportedly be required to provide fuller disclosures about their off-balance sheet investment products and may face a cap on the percentage of their assets such products can account for.

This is not an attempt to snuff out such lending; it has funded much of the infrastructure development that China has used to stimulate its economy since the global financial crisis in 2008, and provided credit to privately owned enterprises that find themselves down the pecking order for bank loans behind state-owned companies and the politically well connected. It has also created high-yielding banking products for wealthy bank customers who otherwise face the miserly savings rates offered by Chinese banks.

This is all a broadening of China’s financial markets that reformers have pushed for. But it is happening haphazardly wherever it can find a regulatory vacuum. Local authorities have run up huge levels of debt–$2.2 trillion, not far off Italy’s market rattling $2.6 trillion–much of it off-balance sheet in special investment trusts. There have also been a string of recent problems with wealth management products, each small in itself but collectively an alarming preview of what could happen on a far larger scale.

Hence the attempt now bring that lending out of the shadows and into the light of the regulated financial system where it can be checked and monitored.


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Averting China’s Local Government Defaults

The Financial Times‘ estimate that China’s banks rolled over three quarters of the 4 trillion yuan ($642 billion) of local government debt that fell due at the end of 2012 to avert defaults puts a hard number on a soft but growing fear that has been gnawing away at China’s policymakers for some years.

Some history bears retelling. Much of Beijing’s stimulus package in response to the 2008 global financial crisis flowed through local government spending on public works. Local government debt rose by 62% in 2009 over the previous year, as local authorities laded up with bank debt–and the banks, state owned, with potential bad debt. Bank borrowing increased by a further 19% in 2010. By the end of that year, China’s central government debt was a modest looking 17% of GDP. Its local government debt was the equivalent of 27% of GDP.

By February 2011, the China Banking Regulatory Commission (CBRC) was alarmed to discover that more than half of new bank lending wasn’t meeting its new credit rules designed to mitigate the build-up of potentially bad loans. The CBRC’s particular concern was direct and indirect lending to the three top tiers of local government, provincial, municipal and county-level local authorities.

The following month, the finance ministry alerted the National People’s Congress (NPC) that “local governments face debt risks that cannot be overlooked,” though the line was buried deep in a budget report. What concerned officials was the risks involved in the 7.7 trillion yuan of bank loans (as of June 30, 2010) made to local governments’ captive investment vehicles. These local officials were using to get round restrictions on direct borrowing. A finance ministry audit turned up more than 6,000 of them. The audit also found that there was no cash flow to repay 23% of their loans. The suspicion was that by the time the ministry made its report to the NPC the numbers had worsened significantly, intensifying a general concern in Beijing about the overall weakness of local-government governance.

By November 2011, officials were fearful that China’s local government debt had reached 13.7 trillion yen ($2.2 trillion; Italy’s outstanding sovereign debt at the time was $2.6 trillion) including a previously uncounted 3 trillion yuan borrowed by townships, the administrative tier of government below counties. Reforms to local government finance started to be put in place and a rolling 2 trillion-3 trillion yuan bailout deployed to shore up loans backing projects with neither collateral nor viable cash-flow to cover their debt service. Banks were also made to plump up their cushions of capital reserves.

These measures were sufficient to keep the situation manageable through last year. The risk of a local government debt default remained low–as long as economic growth remained brisk and state-owned banks could be made to absorb the worst bad debts. When growth slowed in the middle two quarters of 2012, the banks had to take more of the strain. How much more is delineated by the the Financial Times estimates, as is the challenge China’s local governments face in working down their massive debt loads.

There is one intended and one unintended consequence of all this. Banks have all but stopped extending new loans to local governments. Some authorities have turned to the nascent municipal bond market to raise new debt. But others have turned to the shadow banking system comprising unregulated non-bank financial institutions including trust companies. There have been a series of defaults and near-defaults around these in the past couple of months. None catastrophic. At least not yet. If China’s debt bomb seems to be ticking less loudly, that may just be because it has moved.

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January 29, 2013 · 9:14 pm