Why smaller Chinese banks are more vulnerable to wholesale funding withdrawal

Interbank transactions as a share of total funding increased to 12%.

A factor that has enabled medium and small-sized Chinese banks to rapidly increase their exposure to shadow banking assets has been the availability of cheap funding through the interbank market such as interbank negotiable certificates of deposits (NCD), according to BMI Research.

According to data from the People's Bank of China (PBoC), interbank transactions as a share of total funding for medium and small-sized state-owned banks increased to approximately 12% at the end of 2016 from 9.0% in January 2015.

In contrast, the share of interbank funding for large-sized state-owned banks has been relatively stable at around 1.8% over the same period, with deposits accounting for around 80% of their funding base.

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Medium and small-sized Chinese banks are therefore more vulnerable to the withdrawal of wholesale funding as interest rates of these interbank instruments rise amid a gradually tightening monetary policy environment by the central bank and co-ordinated efforts by Chinese regulators to curb system-wide leverage.

In addition, the authorities have been increasing oversight of the growth of the issuance of wealth management products (WMPs), which is also used as a source of off balance-sheet funding for Chinese banks.

Indeed, WMP growth slowed considerably in Q117 to 18.6% y-o-y, from 53.4% y-o-y in the same period last year, and is likely to fall further over the coming quarters. This will therefore weigh on investments on trust and asset management schemes, and consequently, asset expansion.