China’s shadow banking is back in full swing, an unintended side effect of the government’s campaign against financial leverage, which has curbed traditional lending and squeezed bond financing.
Data from the central bank showed that off-balance sheet lending surged 754 billion yuan ($109 billion) in March, taking the first quarter’s total increase to a record 2.05 trillion yuan. Efforts by the People’s Bank of China to curb fresh lending may have prompted borrowers, especially real estate developers, to resort to alternative forms of financing, said Xu Gao, chief economist at Everbright Securities Co.
Since late last year, the PBOC and regulators have taken steps to rein in risks to China’s financial system, including raising short-term interest rates, clamping down on leverage in the bond market, and curbing funding for property speculation. The measures have sent debt-reliant borrowers scurrying to shadow financing, an industry Moody’s Investors Service estimates is worth about $8.5 trillion, and another area where regulators are trying to reduce risk.
“You must tread a fine line,” said Everbright’s Xu. “Choking the bond market to death doesn’t mean the financing needs will be curbed as well. Instead, it will drive funding to areas that are more unreachable for the regulators. At the end of the day, risks may be declining in the bond market, but in the overall financial system, they would be rising.”
The following charts illustrate the measures the government introduced to deleverage the economy, which have contributed to the rebound in shadow banking: The PBOC in January ordered the nation’s lenders to strictly control new loans in the first quarter of the year, putting a particular emphasis on mortgage lending to contain runaway home prices.
The move saw banks extending 4.22 trillion yuan of new loans in the first quarter, 8.5 percent less than the same period in 2016. It was the first year-on-year decline since 2011. The government is trying to contain the possibility of a shock emanating from the property and construction industries, which contribute about 25 to 30 percent of China’s economic output, Moody’s estimates.
The increasing role of shadow banks as providers of finance is among characteristics that have raised the financial system’s vulnerability to a property-related shock, Moody’s said in a March report. In a move to curb shadow banking, financial regulators are working together to draft sweeping new rules for asset-managem-
Net corporate-bond financing in China was negative for three consecutive months through February before logging a positive 32 billion yuan last month, PBOC data showed. The negative streak, during which more bonds matured than were issued, is unprecedented for data going back to 2002, and came amid tighter rules on issuance for companies in certain sectors and a December bond-market rout. If companies can’t raise funds from the bond market, they have to turn to shadow financing, said Lu Zhengwei, chief economist at Industrial Bank Co. The most popular forms of shadow banking, according to PBOC data, are so-called entrusted loan agreements and trust loans. Under the former, a company lends money to another firm with the bank as the middleman, while for the latter, banks use money raised from wealth-management products to invest in a trust plan, with the proceeds eventually going to a corporate borrower.
Banks’ reliance on overnight repurchase contracts contributed to unprecedented bull run in bond market last year, prompting PBOC to start offering longer-term agreements in August to curb market volatility. Those contracts, which typically carry higher rates, saw borrowing costs rise, putting lenders off the repo market and prompting some off them to plug short-term funding needs with shadow financing.