The Chinese government’s efforts to reduce risk in the financial system appear to be slowly showing positive results.
The campaign to unwind risk began in mid-2016, mainly targeted at the interbank funding market and the shadow-banking sector.
The interbank market is the conduit of financing for banks and other financial institutions. This year, volumes have been contracting. In the first eight months of the year, interbank assets fell by 3.2 trillion yuan (US$480 billion) and liabilities slumped by 1.4 trillion yuan.
Joint-stock banks showed the steepest decline, with interbank assets diving 45 percent, according to the China Banking Regulatory Commission.
The regulator said that the declines mean more money is being channeled into the “real” economy instead of idling in the financial sector.
The deleveraging has taken its toll on the net interest margins of smaller and mid-sized lenders that have relied on borrowing from the interbank market. Their margins fell sharply in the first half, while the nation’s largest banks improved their margins. That divergence is expected to continue through the second half, Noel Chan, a banking analyst at UBS Securities, told Shanghai Daily.
“We look at the deleveraging as akin to a mild forest fire, allowing the stronger trees to grow taller out of the ashes of the weaker trees and bushes,” Nomura noted in its recent Asia special report.
Amid the structural shift from interbank assets to traditional credit assets, Nicole Zhou, a partner at McKinsey & Co, said that banks “should always strengthen their core while growing fee income.”
The shadow-banking sector, which functions largely outside the banking regulatory system, is a tougher nut to crack when it comes to reducing financial risk.
That sector operates wealth management products, “underground” financing and off-balance-sheet lending. Its size in the six years to 2016 surged from 19.4 trillion yuan to 122.8 trillion yuan, according to a recent report by Nomura.
That rampant growth triggered alarm bells in a government afraid that a collapse in any sector of the financial system could undermine the whole economy.
Attempts to bring more order to the sector have been paying off. Wealth management products, a major driver behind the boom in shadow banking, lost ground for seven straight months, registering a 27 percent decrease year-on-year.
At the end of 2016, China’s asset management industry was valued at more than 60 trillion yuan, according to the People’s Bank of China.
The value of interbank wealth management products has been reduced by 22 trillion yuan this year. City and rural commercial banks that relied heavily on interbank financing in recent years suffered slumps of 40-90 percent.
Entrusted loans, another type of the informal lending, recorded a year-on-year reduction of 151.4 billion yuan in August. However, trust loans recorded a rise of 40.7 billion yuan, while undiscounted bankers’ acceptances reported a gain of 61.8 billion yuan over the same period last year.
The government’s crackdown on riskier shadow banking has led companies to resort to traditional banks for funding. Chinese commercial lenders extended 1.15 trillion yuan in corporate loans in August, up almost 350 billion yuan from the prior year, China’s central bank said recently.
Government attempts to implement controls always come with loopholes. Financial regulators are seeking to close them.
The National Financial Stability and Development Committee was set up in July to shore up weak links in supervision and strengthen coordination among the various regulators.
The central bank is now including asset management business in its prudential oversight. As of September 1, financial institutions have been banned from issuing negotiable certificates of deposit, a popular interbank debt instrument, with tenures exceeding one year.
The banking regulator has rolled out a series of policies to tighten financial regulations implemented earlier this year. For example, banks have been asked to monitor their interbank liabilities so that they don’t exceed a ceiling of one-third of total liabilities.
The government curbs aim to force the banks to adjust their balance sheets and profit models, Li Yamin, a banking analyst at Pingan Securities, said in an interview with Shanghai Daily.
“The adjustment is far from completed,” Li said. “It will carry on through the second half. It might take another year for some unlisted lenders to make the adjustments.”
UBS Securities’ Chan said the current crackdown is mainly focused on listed banks, but the firm’s research points to even more serious problems in the unlisted realm.
“It will take the decision-makers a long time to deal with the shadow banking activities, which weren’t built in a day,” he said. “In a sense, the deleveraging process has just begun.”
Sophie Jiang, head of Hong Kong and Chinese m bank research at Nomura, said banks with sizable exposures to leveraged financial assets — both on and off balance sheets — are yet to undergo fundamental changes.
“We believe that China will proceed with its efforts on financial deleveraging,” Li Jing, manager director of JP Morgan said in a recent Shanghai media briefing. “It is quite likely that the authorities will take a progressive and measured approach to avoid potential adverse impact on economic growth and financial stability.”