China’s latest move to deleverage the economy and crack down on the shadow banking sector could prove to have too much of a destabilising impact upon financial markets to ever be properly enforced.
The Chinese central government just recently stepped up its regulatory campaign against the shadow bankings sector with the launch of the draft version of the “Guidance Opinions Concerning Standardisation of Asset Management Operations by Financial Institutions (Draft for Solicitation of Opinions)” (关于规范金融机构资产管理业务的指导意见), which aim to tackle the problem of the “implicit guarantees” enjoyed by certain investment vehicles such as wealth management products.
Some market observers now argue that the move is triggering instability in Chinese financial markets, with the Shanghai Composite Index dropping over 2% last Thursday, just as the yield on 10-year sovereign bonds breached the 4% threshold for the first time in over three years.
According to some analysts some investors could be concerned that a clampdown on WMP issuance could impede the flows of money into Chinese stocks, while of tightening on bank fund flows could prompt a withdrawal from sovereign debt.
The draft Guidance Opinions cover 96 trillion yuan in investment vehicles categorised as asset management products, including WMP’s and trust products.
The Opinions provides for differentiated regulation of asset management products on the basis of features such as their investment targets.
This marks a major departure from the current framework that applies different approaches depending upon the nature of the issuer, dovetailing neatly with a regulatory structure that has separate and distinct authorities for the banking, insurance and securities sectors.
According to Issaku Harada and Yusho Cho of the Nikkei Review, this system has led to a game of “whack-a-mole,” with issuance switch fleeing from one sector to another once regulatory scrutiny intensifies.
In order to address the problem of the implicit guarantees or “rigid payments” that investors perceive WMP’s to enjoy, the Opinions also forbid financial institutions from using their own funds to make up losses.
According to Harada and Cho the opinions could prove too stern a measure for the Chinese banking system given the importance of WMP’s for smaller institutions. As of the end of 2016 there were around 29 trillion yuan in WMP’s outstanding in China, 80% of which were off-balance sheet.
“If they go into force, the regulations on WMPs could crimp weaker regional banks and small and midsize lenders’ ability to raise funds,” they write. “Such institutions have dangled the promise of high returns to attract capital.
“If deprived of this draw, they probably will have to offer higher interest rates on deposits. This could put upward pressure on deposit rates at big banks too, straining lenders’ profit margins.”
While the Opinions are scheduled to come into force in July 2019, providing enough time for financial institutions to make adjustments for their effects, Harada and Cho say they may never be enforced due to the size of their potential impacts.
“In 2013, China’s banking authority banned issuers from pooling funds raised through WMP’s, but that rule has been ignored.
“If the latest clampdown on shadow banking proves too destabilising to the financial markets, Beijing may even undermine its own efforts in order to prevent the social unrest that it fears.”