Illumination alone won’t slow China shadow banks

February 27, 2013

By John Foley

(The author is a Reuters Breakingviews columnist. The opinions expressed are his own)

When it comes to China’s shadow banks, switching on the lights isn’t enough to make the risks go away. The country’s lenders may soon be asked to disclose their off-balance sheet lending activities, starting with a trial in Shanghai, according to the Financial Times.

The watchdog’s task is not an enviable one. The China Banking Regulatory Commission’s job is to make sure banks are safe without killing off financial innovation. In practice that has led to a kind of cat-and-mouse game. The CBRC issues broad principles, but then introduces specific rules when activity gets to a certain scale. One example is its ban on banks pooling their wealth management products. That should prevent them from repaying investors in one product with the cash raised from another – effectively a Ponzi scheme. Yet some banks are still exploiting loopholes.

The regulator’s other idea of capping issuance of wealth management products at 20 percent of a bank’s deposit base is also wise. Some banks may already be far beyond that threshold. Bank of Beijing and Bank of Communications have been particularly active issuers of wealth management products, Fitch Ratings warned in December.

Based on the CBRC’s estimates, off-balance sheet products issued by banks accounted for 7.8 percent of total deposits at the end of 2012. So the new rules would still leave room for system-wide issuance to more than double. They also wouldn’t stop products from getting into trouble – recent near-failures at Huaxia Bank and CITIC Trust didn’t lack for documentation. Nor do the rules help clarify what should happen when things go wrong. In theory, investors should be prepared to shoulder defaults, but they haven’t so far.

Shadow banking is part of China’s broader boom in non-bank lending: the stock of outstanding loans reached 44 percent of GDP in 2012, according to Credit Suisse, and accounted for half of the total financing of China’s economy in January. Keeping that credit flowing is pre-eminent for the country’s leaders as they attempt to keep the economy expanding. It won’t just be up to bank regulators to decide whether shadow banking has a happy ending.

 

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