Jump in China’s shadow banking products potentially destabilising
THE 30% increase in wealth management products (WMPs) held in off-balance sheets of Chinese banks is potentially destabilising but in the short term, it is unlikely to have a major impact.
“This is given that China still has ample reserves,’’ said Chris Eng, head of research, Etiqa Insurance & Takaful. “But it is surprising that it grew by 30%.’’
“It is certainly a potentially destabilising factor,’’ said Pong Teng Siew, head of research, InterPacific Securities.
The expansion of this form of shadow banking, which grew to US$3.8 trillion, with money eventually being diverted to quasiloans and bonds, outpaced the 10% growth for normal lending during the same period, raising risks for the broader economy and undermining the country’s “deleveraging” efforts, said
Bloomberg, quoting the People’s Bank of China (PBoC) in its quarterly monetary policy report.
There is concern over risks associated with high yielding products.
“The issue is that with high yields, the funds obtained via WMPs may well be invested into risky classes of companies, sectors, ventures, assets and derivatives.
“These can entail asset liability and maturity mismatches that can easily lead to a liquidity crunch, if the underlying investment turns sour, for whatever reason,’’ said Suhaimi Ilias, group chief economist, Maybank Investment Bank.
Any adverse development can spoil the current global reflation story.
“Even though China’s WMPs are not necessarily ‘integrated’ with the global financial system and more ‘local’ in nature, any adverse development can be a spoiler to the current global reflation story.
“Among other factors, that is based on China’s economic growth stabilising and picking up, together with the acceleration in inflation, that have buoyed equity and commodity markets,’’ said Suhaimi.
In fact, there are mounting concerns in China on three highly interconnected risks which could spill over to the formal banking sector, said Lee Heng Guie, executive director, Socio Economic Research Centre. These are shadow banking (40%-70% of GDP); real estate bubble as well as high public and corporate debt (about 255% of GDP at end 2015).
“The size and opacity of shadow banking activities in China has been an ongoing concern amidst the regulator’s strengthened oversight on offbudget balance sheet lending from trust companies, brokerages, microlenders, pawn shops and real estate companies,’’ added Lee.
China’s credit expansion has sparked concern. Credit to gross domestic product (GDP) has accelerated rapidly and surpassed 200% since 2015. In mid-2016, it stood at 210% (South Korea 195%; Singapore 150% and Thailand 120%). In fact, Bank for International Settlements (BIS) has warned that China’s excessive credit growth is signalling an increasing risk of a banking crisis.
“An early warning of financial overheating, as measured by the credit to GDP gap, hit 30.1 in the first quarter of 2016,’’ said Lee, quoting BIS. “Any level above 10 signals a crisis occurring in any of the three years ahead.’’
“Equally worrisome is the reaction in the financial markets to the government’s effort to rein in credit, which has led to a sharp tightening of credit conditions. This was evident in the recent spike in money market rates,’’ noted Zahidi.
A word of caution on any policy miscalibration. “In its enthusiasm to address the problem of financial imbalances, a policy miscalibration by the government could lead to financial market chaos.
“PBoC’s move to raise rates in the open market and on funds lent through the standing lending facility has also impacted the entire yield curve. It is worth noting that China’s bond market has corrected sharply in recent times.
“And additional policies to rein in credit could further dent the country’s already fragile bond market,’’ said Zahidi.
Addressing the debt issue is critical. “Addressing debt concerns in the coming years will be critical to avoiding a financial crisis over the medium term. Investors fret that China will possibly avoid making the tough decisions and favour status quo instead, heightening financial stability risks in the future.
“It is comforting that the Chinese government has unveiled several measures aimed at mitigating the worst of the dangers. But it remains to be seen just how effective these will be, as slowing economic growth constrains the debt restructuring process,’’ said Lee.
China is shifting from growth to financial stability. “There is also regulatory risk as PBoC is turning its attention to WMPs, much like the previous attention on local government financing vehicles amid concerns over local government borrowings and debt.
“This can, among others, lead to a drastic change in the belief or perception that there are implicit guarantees by the government, something that has sustained the growth in WMPs,’’ said Suhaimi.
“The fact that the regulators are looking into this reinforces our view that China’s policy this year is shifting from growth to financial stability.
“This can help to address the risk to China and global financial systems arising from the growth in shadow banking,’’ added Suhaimi.