China tightens control of shadow banking

Tagged as 'credit positive' by Moody's.

According to Moody's Credit Outlook report, last Monday, the China Banking Regulatory Commission (CBRC) announced a series of measures to tighten controls of financial institutions, including tightening banks’ wealth management activities and curtailing the operations of key non-bank sectors.

Here's more:

The measures are credit positive for banks because they will reduce banks’ counterparty risk exposure to other banks and non-bank financial institutions, potential claims from mis-selling of wealth management products and reputation risk.

Currently, banks can dispose of their loans by using them as underlying investments of wealth management products sold to customers, and later reverse that process. This allows banks to temporarily remove loans from their balance sheets, thereby reducing their provisioning and capital requirements and keeping their loan-to-deposit ratios below the 75% regulatory ceiling.

Other financial institutions often buy such wealth management products, thereby creating interbank exposure to these loans. By banning banks from repackaging their loans as wealth management products, the regulator is addressing this risk.

Because the CBRC is tightening regulations on all types of shadow banking (trust companies, microfinance companies and credit guarantee companies), its measures address the risks associated with the proliferation of financial services outside the traditional bank channel, which tend to lack transparency, blur the risks borne by banks and investors and create opportunities for regulatory arbitrage.

The increasing interconnectedness between banks and non-banks along with a lack of adequate supervision of non-bank financial institutions exposes banks to contagion risk from these entities. Many non-bank financial institutions also participate in the interbank market, exposing banks to counterparty risk.