Regulatory Crackdown Tames China’s Shadow Banking Sector: Fitch

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A new report from ratings agency Fitch says that China’s shadow banking sector has shrunk as a result of the multi-agency crackdown launched by the central government at the start of 2017.

Fitch Ratings points out that as a result of the crackdown interbank lending – considered a key form of shadow banking activity, has seen its first decline since the turn of the decade.

Data from the China Banking Regulatory Commission indicates that system-wide interbank assets fell 13.8% year-on-year as of the end of August, while liabilities had declined 1.6%.

According to Fitch joint-stock commercial banks saw the sharpest decline in interbank activities, with a drop of 45% as of end of August compared to the start of 2017.

Interbank lending is considered a major form of shadow banking in China, involving the channelling of funds by larger banks to small banks who then lend them to final borrowers.

According to analysts this serves to heighten risk by obscuring the final destination of funds for both the banks themselves and regulatory watchdogs, while also increasing the cost of financing by increasing the number intermediary links.

Other forms of shadow banking activity have also taken a hit, with entrusted loans declining for the first time since 2008 for the first eight months of the year.

Growth in wealth management products has also slowed, following a spate of roaring growth that saw outstanding WMP balances expand by over 40% per annum on average since 2013 to reach 40% of China’s GDP by the end of 2016.

Fitch now estimates that the outstanding WMP balance has fallen by around 10% since the start of the year.

Fitch points out that efforts to combat shadow banking should help reduce risk created by rapid growth and the increasing interconnectedness of the Chinese financial sector, which has made lenders more vulnerable to funding and liquidity crises.

The ratings agency expects the central government to continue to place shadow banking under heavy pressure and scrutiny, given strong statements made by CBRC in relation to tackling financial sector risk in September.

While the crackdown on shadow banking may have heightened the risk of liquidity shortages, Fitch points out that the Chinese central bank has flagged the use of various policy instruments in order to maintain stable liquidity.

A key example of this is the central bank’s recent decision to the reduce the reserve ratio requirement by between 50 and 150 basis points for commercial banks that meet very low lending thresholds for financial inclusion targets, such as rural and micro enterprises.

According to Fitch the move will “alleviate pressure on borrowing costs for targeted sectors, while maintaining a grip on banking sector risks.”

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