China’s $2 trillion of shadow lending turns focus on smaller banks
REGIONAL BANKS in China’s rust-belt provinces are driving the rapid expansion of shadow banking in the country, fueling a web of informal lending that poses wider risks to the financial system, according to a study by UBS Group AG.
Smaller rust-belt banks like Bank of Tangshan Co. and Baoshang Bank have been using products such as trust beneficiary rights and directional asset-management plans to hide the true state of their bad loans and circumvent lending restrictions, the study by analyst Jason Bedford said.
Others have been using the shadow loan instruments to diversify away from lending in their struggling home provinces, exposing themselves to a much wider spectrum of Chinese corporate risk in the event of a default, according to the report.
By analyzing 237 Chinese banks, many of them small and unlisted regional lenders, Bedford casts a new spotlight on underground financing and the risks it poses to the nation’s $35 trillion banking industry.
Shadow loans grew almost 15% to 14.1 trillion yuan ($2.3 trillion) by December from a year earlier, equal to about 19% of economic output, he estimates.
“This is a sleeper issue,” Bedford wrote. “The remarkable level of concentration in regional banks in rust- belt region banks, combined with evidence that these assets are increasingly being used to roll over loans to existing borrowers as well as being swapped between banks without a clear transfer of risk are alarming.”
Accounting for this financing, Chinese banks’ nonperforming loans could be three times higher than the official published level, he said.
By recording such lending under “investment receivables” rather than “loans” on their financial statements, banks were able to disguise what is in effect lending, to get around regulatory lending curbs or heavy reliance on wholesale funding. Such financial engineering also enabled some lenders to overstate their capital adequacy ratios, understate nonperforming loans and reduce provision charges.
Authorities have renewed their campaign against financial leverage since the beginning of April to rein in risks associated with China’s $28 trillion debt pile, with a focus on unraveling interconnectedness among institutions and curbing shadow financing.
Signs have emerged in recent months that smaller banks have been harder hit by the campaign and their shares have underperformed as a result.
Banks with high levels of shadow loans would be most exposed to any drastic regulatory changes that could lead to a surge in bad-debt recognition. The transfer of shadow credit into formal credit could cause borrowers to breach loan covenants and single borrower limits, eventually leading to “a significant recapitalization of a large swath of the banking sector,” Bedford wrote. • Bloomberg