Growth in China’s Core Shadow Banking Rises to Three Year High: Moody’s

A new report from ratings agency Moody’s Investors Service indicates that growth in core Chinese shadow banking has risen to its highest level since mid-2014.

According to the report core shadow banking saw year-on-year growth of 15.6% in Q2 2017,  for the highest rate of increase since mid-2014.

Moody’s defines “core shadow banking” as that part of China’s total social financing (a broad measure of credit in the Chinese economy) comprised of entrusted loans, trust loans and undiscounted banker’s acceptances

According to the report surging growth in trust loans was the primary driver behind much of the increase in Q2 core shadow banking.

Despite the three year peak in core shadow banking growth, Moody’s notes that tighter regulation of the sector served to spur growth in conventional bank loans, making them a key driver of the expansion in total social financing.

Regulatory constraints on bond and equity financing as well as other parts of the shadow banking sector may have driven some corporate borrowers to turn to trust loans and conventional loans for funds. 

“Changes to loan supply sources have improved transparency, which could perhaps strengthen the finance sector’s resistance to unexpected shocks,” said Moody’s analyst Xu Jing.

“However, what’s still uncertain is whether [trust and conventional] loans are enough to replace the capital funds that are provided by that part of the shadow banking sector currently subject to more strict regulation.”

Trust loans began to see more rapid growth in the second half of 2016, likely due to the heavy regulatory crackdown on the wealth management products which had recently emerged as a mainstay of Chinese shadow banking.

According to the report new regulations proposed by the China Banking Regulatory Commission in July could further spur growth in trust loans by making them the only means for banks to invest in non-standard debt assets.

“This could further compel shadow loans that had previously flowed to securities companies and fund subsidiary companies to flow back to trust channels,” said the report.

Significant slowdown in growth of wealth management products

The report notes that growth in wealth management products has eased significantly since the start of the year as a result of heightened regulatory scrutiny.

As of May 2017 the balance of outstanding wealth management products either issued or sold by banks was 28.4 trillion yuan, equal to 19.8%of their total deposit balance, for year-on-year growth of 9.0%.

This figure is well below the growth rates of 23.6% for the same period in 2016 and 56.5% in 2015.

Moody’s nonetheless believes that wealth management products continue be a key source of risk for China’s financial system, particularly given the rise in the wholesale investment ratio to an historic high.

Interbank wealth management products have risen from 3.3% of all wealth management products just two years ago to 20.6% by the end of 2016, while interbank investment comprises 53.9% of net growth in the wealth management product balance.

The increased use of wealth management products for interbank funding serves to exacerbated the layered credit” effect that obscures the end destinations of capital and sources of risk. 

“Interbank purchases of wealth management products has increased (as a ratio of all wealth management products), driving growth in wealth management products in 2016, and expanding linkages between conventional banks and shadow banking,” said the report.

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