Date
16 October 2017
Chinese regulators are seeking to redefine what exactly constitutes shadow banking. Photo: Bloomberg
Chinese regulators are seeking to redefine what exactly constitutes shadow banking. Photo: Bloomberg

Shadow banking definition becomes complicated

Yan Qingmin, vice-chairman of the China Banking Regulatory Commission (CBRC), made some interesting remarks on February 17.

In an apparent attempt to clear the name of commercial banks, Yan said Chinese lenders’ wealth management business should not be categorized as shadow banking because such activity is covered by a separate regulatory and supervisory framework, has clear legal status, presents controllable liquidity risks, provides sufficient disclosure and undertakes no high-leverage operations.

But he was quick to balance his view by saying that some wealth management business that eludes supervision is similar to shadow banking activity — and that regulators must remain alert. As of Sept. 30, outstanding bank wealth management products were worth 9.9 trillion yuan (US$1.63 trillion), according to the CBRC.

Yan’s remarks ran contradictory to what the market and academics have believed for quite some time. In China, credit extended by non-traditional loan business is supposed to be deemed as shadow banking. So, most observers held the view that the wealth management business, even if it is conducted by traditional banks, is definitely part of shadow banking.

For example, an annual Chinese Academy of Social Sciences report lists wealth management products and trust funds as two basic sources of shadow banking. Based on that definition, the report said shadow banking amounted to 14.6 trillion yuan by the end of 2012. If other non-mainstream sources, such as pawnshops, small-loan companies, private lending as well as asset and securitization management, were taken into consideration, China’s shadow banking capital hit 20.5 trillion yuan in a broad sense, the report said.

Last year, the CBRC placed limits on banks’ wealth management business, under a document that aimed to crack down on shadow banking businesses. In this sense, the CBRC itself, at that time, also agreed that wealth management activities are part of shadow banking.

What caused the U-turn in the attitude now? Taking a deep look, we can say that there are at least two motives.

On one hand, Yan tries to dismiss recent fears at home and abroad that China’s financial system could encounter big problems due to rampant and uncontrollable shadow banking activities. A meltdown of the financial market, featuring a default crisis and government bankruptcy, will add to the possibility of a hard-landing of the Chinese economy.

So, Yan stood up to defend the Chinese banking system. By removing wealth management business from the shadow banking system, he conveys the message that this business is generally safe with low risk. The de-categorization also helps easily halve the figure of China’s overall shadow banking in a broad sense, a move that will build market confidence and reduce global pessimism on the Chinese economy.

On the other hand, Yan tries to stress the need of regulation by redefining shadow banking. From what he said, he conveys an idea that shadow banking is not defined by the form of the product, but by whether the product is subject to regulation and supervision by authorities. Following this logic, we may come to the conclusion that the CBRC will continue to use regulation instead of deregulation to handle the shadow banking issue.

But as past experience has shown, authorities were often a step slower in regulating market participants’ shadow banking activities, with banks, trust funds, loan companies and other financing vehicles creating new methods to bypass supervision.

Although private lending has existed for centuries, shadow banking has become a big problem only in recent years.

Before 2008, the vast majority of lending in China was done through traditional banking. The government launched massive stimulus during the global financial crisis, but traditional bank loans were inadequate to meet the capital demand needed to support the stimulus projects.

Commercial banks thus used many financial tools or innovations that are now classified as shadow banking to provide loans. The main tools or innovations are wealth management products, loans through trust companies, entrusted loans, inter-bank repurchase agreements and bank guarantees.

In this sense, shadow banking did cater to the market needs and helped create a multilayer financing market, but it also raised the possibility that it will get out of hand due to high leverage ratios and big risk appetite.

Apart from supervision, a comprehensive approach that also combines monetary policy, financial innovation and deregulation is needed to handle mounting shadow banking loans.

In this sense, it is more important for authorities to press ahead with deregulation moves such as interest rate liberalization and allowing private capital to enter the banking industry more freely. By doing so, shadow banking players can enjoy lower financing costs like traditional banks.

This means an interest rate gap between traditional banks and shadow banking will be narrowed or leveled. That will reduce their risk appetite and curb traditional banks from lending too much to shadow banking players, bringing down the country’s overall leverage ratio to a reasonable level.

– Contact the writer at [email protected]

RC

The writer is an economic commentator. He writes mostly on business issues in Greater China.

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