China’s $2 tril­lion of shadow lend­ing turns fo­cus on smaller banks

Business World - - BANKING & FINANCE -

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

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