China’s drive to reduce its debt burden has shifted into a higher gear following the Communist Party’s twice-a-decade congress in October.
Regulators have set their sights on a key pressure point -- shadow banking -- with rules around asset-management products tightened last week as they seek to bring the market under control.
But these popular, high-yielding products are just one slice of China’s sizable banking leverage pie, characterized by state media as the “original sin” of the financial system.
Even if credit growth eases, China’s debt is on track to be more than three times the size of the economy by 2022, Bloomberg Economics estimates. To understand why Beijing is taking on this challenge, you need to break it down.
While the drive to reduce the debt load has been having an impact, China still has a ways to go -- as these charts show.
Leverage has been swelling over the past decade, partly because policy makers were trying to cushion a slowdown in growth from the old normal of 10 percent plus. What’s fueled the debt machine has been a rapid expansion in household and corporate wealth looking for higher returns in a system where bank interest rates have been held down.
The equivalent of trillions of dollars are held in all manner of assets in China, from the high-return wealth management products to so-called entrusted investments.
Taking the heftiest piece of the leverage pile first, wealth management products have had a precipitous rise over the past few years, but now seem to be feeling the heat of deleveraging. This is the asset class that is coming under renewed scrutiny from regulators.
A way for borrowers who have trouble getting traditional bank loans to secure funding, WMPs have grown in popularity as they typically give savers much higher yields than banks offer on deposits.
WMPs are also a hit because they give lenders a way to keep loans off their balance sheets, and to skirt regulatory requirements when channeling funds to borrowers, according to Raymond Yeung, chief economist for Greater China at Australia & New Zealand Banking Group Ltd. in Hong Kong.
Regulatory moves have seen the amount of WMPs outstanding taper off from a peak in April, with the latest figures showing levels holding steady as of the end of June. The latest measures, unveiled on Friday, seek to increase supervision while removing the potential moral hazards posed by the investments.
But WMP investors believe the government will always have their back: read more.
Turning to loans by banks to non-financial institutions, this is an area that’s only started to come off over the past few months, edging down from a peak in June.
President Xi Jinping has backed the deleveraging drive, which he’s characterized as a way to cleanse risk from China’s financial system. People’s Bank of China chief Zhou Xiaochuan has also thrown his weight behind addressing the debt issue, delivering a string of warnings about it over the past month.
Since regulators ramped up their measures to curb financial leverage at the start of April, China’s shadow banking activities have been in the cross-hairs.
The most popular forms include entrusted loan agreements (when a company lends money to another company with the bank as the middleman), trust loans (where banks use money raised from WMPs to invest in trust plans, with the proceeds eventually going to a corporate borrower) and bankers’ acceptances (a bank-backed guarantee for a future payment).
Data compiled by Bloomberg Economics tracking all three forms show shadow banking has held its own amid the debt crackdown, reaching a fresh record 26.8 trillion yuan ($4 trillion) at the end of August, the latest data available.
Shadow financing is seen as one of the culprits behind China’s property-price surge, and regulators have banned private-equity lending to developers for land purchases. Banks also were told in March to submit reports on their entrusted investments -- funds that Chinese lenders farm out to external asset managers -- and Beijing extended the deadline mid-year after some struggled to determine the scope of their exposures.
More directly connected to financial markets are repurchase agreements, where participants can get cash for set periods. A key tool for officials to rein in borrowing has been boosting funding costs in the money market.
And indeed, the amount of repos outstanding has come off since reaching a peak at the end of June, dipping to 9.63 trillion yuan at the end of October.
In March, the PBOC hiked rates on reverse-repurchase agreements and also raised the cost of medium-term loans. However, a selloff in government debt -- triggered by concerns over deleveraging -- has seen the central bank recently bolster liquidity to the market through the use of reverse repos.
Negotiable certificates of deposit are relative minnows in China’s ocean of leverage, but they are a lifeline for smaller banks that have difficulty competing for savings against the big state lenders.
NCDs morphed into a way for small banks to fund purchases of each other’s WMPs, with a circular arrangement developing whereby the banks selling the products would then channel the proceeds into the bond market, resulting in a mismatch between the shorter-term NCDs and other debt investments.
Foreign investors are fans of the debt: read more about that here.
The amount of NCDs has fluctuated this year, but has held above 8 trillion yuan since June.
Earlier in the year, the PBOC was said to be mulling requiring lenders to re-classify NCDs as interbank liabilities, a move that would likely quell their growth because of limits on how much interbank debt banks are allowed to hold relative to their overall liabilities.
China’s monetary authorities for years focused on incubating innovation in the financial system, after decades when Soviet-style command and control was the model. Having successfully overseen an explosion in new types of credit, they are now having to pivot into the role of gatekeepers and supervisors.
“On the one hand, they don’t want this overall deleveraging to have any negative impact on real economic activities,” ANZ’s Yeung said in August. “At the same time, they know that if they don’t do it right now that it will become another financial bubble pretty soon.”
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