China to tighten shadow banking rules

Past explosive growth in China's shadow banking system could slow down after new transparency requirements take effect

Story highlights

  • China to rein in shadow banking system by requiring banks to provide greater disclosure
  • Chinese shadow banking system has quadrupled in size since 2008 to about $3.2 trillion
  • Funds were crucial in reviving country growth last year but now pose risk to stability
  • New rules could make it tougher for banks to funnel deposits into off-balance sheet vehicles

China will rein in its shadow banking system by requiring banks to provide greater disclosure about their off-balance sheet activities, according to people briefed on the new rules.

The Chinese shadow banking system -- credit flows beyond traditional bank loans -- has quadrupled in size since 2008 to about Rmb20tn ($3.2tn), or 40 per cent of economic output. These flows were crucial in reviving the country's growth last year. But banking analysts and rating agencies have warned that they pose an increasingly serious risk to Chinese economic stability.

There is also discussion about whether to establish a hard cap on the number of off-balance sheet investment products that banks can issue as a percentage of their assets.

Taken together, the new regulations could lead to a slowdown in the explosive growth of China's shadow banking by making it tougher for banks to funnel deposits into off-balance sheet vehicles.

But the moves would not spell the end of shadow banking. Instead, they reflect a consensus among policymakers that credit flows outside the banking system are a healthy development for China, so long as they are monitored and kept in check.

The disclosure requirements will begin as a trial in Shanghai in late March or early April, according to a person who has seen the draft rules. Banks will be asked to register their wealth management products or WMPs -- deposit-like instruments that offer higher yields and are mostly held off-balance sheet -- with the local regulator.

"The main thing is monitoring the risks of the WMPs," the person said. "The disclosures will fully cover the size, the variety, the maturity and the interest payment information for the products."

So long as banks pay back the principal and interest at maturity, which is typically one year or less, it will be easy for them to continue selling new investment products, he said.

More radical yet is the debate over establishing a hard ceiling on the issuance of the WMPs. Two bankers said they had been informed that the regulator was considering limiting such assets to 20 per cent of their deposit base.

Currently, WMPs amount to 10 per cent of total deposits in the Chinese banking system. But that is up from virtually nothing three years ago. Smaller banks have been particularly aggressive in their issuance of WMPs as a way of attracting new customers and several are already near the 20 per cent mark.

It is not clear whether the cap would be enforced as a rule or simply given to banks as a guideline.

Until recently regulators had taken a permissive stance towards shadow financing, arguing that was an important part of channelling money flows away from banks, which have historically provided about 90 per cent of credit in China through ordinary loans.

Zhou Xiaochuan, the central bank governor, said late last year that shadow banking in China was much smaller in scale and better controlled than its counterpart in developed economies, where lending by hedge funds and investment banks magnified the global financial crisis.

However, problems with three separate bank-issued investment products in December raised the spectre of defaults and appear to have contributed to the change in attitude.

In a speech four weeks ago Yan Qingmin, assistant chairman of the China Banking Regulatory Commission, said that some banks were improperly creating asset pools with their WMPs -- a practice whereby inflows from new investors can be used to repay old investors and thereby cover up failed investments.

A slowdown in the issuance of WMPs would limit the expansion of shadow banking in China, depriving companies such as property developers of a vital alternative source of cash since the regulator has all but stopped banks from lending to high-risk borrowers.

In a note to clients last week Zhang Zhiwei, an analyst with Nomura Securities, warned about the economic impact of a policy response to the rising risks in shadow banking.

"We believe the government will tighten policies to contain these risks and, in turn, drag down growth in the second half," he said.

Additional reporting by Emma Dong