China shadow banks feel stronger central bank grip

HONG KONG: The People's Bank of China is looking tough. The central bank has rolled out fresh restraints for the sprawling $15 trillion asset management industry. Insurers, banks, brokerages and commodities houses may howl to their respective industry regulators. Unfortunately for them, a callous PBOC is firmly in charge.

This will ultimately take a big bite out of earnings at many financial services providers. Non-financial companies will be hit too; given weak returns in core businesses, many Chinese outfits have transmogrified into shadow bankers - an activity criticised by officials as "casting off the empty for the real".

Under the new regime, to come into full effect by June 2019, financial institutions cannot use asset management products to invest in loans made by commercial banks. Nor can holdings in such instruments be used as collateral. Nonfinancial firms are prevented from issuing them, and heavily indebted companies will not be allowed to invest in them. Pooling the capital from multiple vehicles, allowing maturing products to be rolled over indefinitely, will be curtailed.

In an environment of low defaults and easy liquidity, these activities helped margins at insurers, brokerages and smaller banks. They also helped some creditworthy private companies, unable to borrow from state banks, to raise funds. But as interest rates rise, too much debt has been hidden off balance sheet inside Byzantine fund structures.

Too much risk is mispriced thanks to implicit guarantees explained, sotto voce, at the teller window. Other products promise implausible rates of return. So on balance, this intensified campaign is welcome. Past enforcement has been blunted by regulatory arbitrage.