China’s new shadow banking rules signal further push to tackle systemic risk
China’s latest rules on so-called cash wealth management products, or cash WMPs, point to renewed efforts by regulators to reduce risk in the shadow banking system, a major source of funding for weak or heavily indebted businesses that are unable to obtain loans from traditional banks.
The rules, announced on June 11, banned banks and wealth management companies from using the money collected by WMPs in cash to invest in stocks, convertible bonds, asset-backed securities and bonds. companies with low ratings, according to the China Banking and Insurance Regulatory Commission, or CBIRC. These products will also be subject to a maximum leverage ratio of 120%.
In addition, financial institutions will need to stress tests and invest at least 5% of the net worth of their WMP funds in cash in low risk assets such as government bonds and central bank bills.
“China’s latest policies have started to slow the pace of credit growth and crack down on the shadow banking system as it seeks to normalize monetary policy and reduce potential risks now that the economy recovers. is accelerating, “said Bruce Pang, head of macroeconomics in Hong Kong. and strategic research at China Renaissance.
Beijing’s years of efforts to contain risk in shadow banking were shelved last year due to the pandemic. As the Chinese economy recovers faster than that of other countries, analysts say it now has an opportunity to relaunch its efforts to target systemic risk, even at the expense of some loan-led growth. In addition to the WMP cash rules, the government has said legacy banks will have until the end of 2021 to comply with a more stringent set of asset management rules that will require them to dispose of long-dated assets. , sever ties with intermediaries and stop pooling money. different heritage products to invest or repay loans.
At the end of March, the outstanding balance of cash management products in China stood at 7340 billion yuan, according to the China Banking Wealth Management Registration and Depository Center. It accounted for about 29% of the nation’s entire 25.03 trillion yuan wealth management market, up 7.02% from the previous year.
WMPs in China are sold by financial institutions as savings or investment products and do not appear on their balance sheets, making them part of the shadow banking system where the scale of risk is largely uncertain for regulators. These products are also often marketed with yields well above deposit rates, prompting them to invest in risky assets as well as to grant loans to highly leveraged companies, especially real estate developers, which are often shunned. through the formal banking system.
WMPs have also become more complex in recent years, which worries regulators in terms of systemic risk assessment and control. These products sometimes involve several layers of securitization or investment intermediaries. There were also instances where larger banks packaged loans as WMPs and sold them to smaller lenders who needed fresh funds.
While the rules went into effect immediately for new issues, financial institutions had until December 2022 to rectify existing products.
“We expect a large portion of the assets to mature by [18-month] deadline. Thus, there should be no material impact on existing products. But we expect future product returns to be lower given the evolution of investment assets. The rules are also likely to reduce market demands for replenishment bonds, ”said Iris Tan, senior equity analyst at Morningstar.
A level playing field
China Renaissance’s Pang said the stricter rules would give money market funds, a direct competitor to cash WMPs, a level playing field.
“We also expect returns from cash wealth management products to be reduced, given the stricter and more explicit regulatory limits now in terms of credit quality, liquidity, maturity, concentration and leverage. “said Pang.
He added that the yield of cash WMPs is currently around 50 basis points higher than that of money market funds, down from a spread of around 75 basis points when the draft rules were first released. times in December 2019. He expects the gap to narrow further. .
China was the first major global economy to recover from the COVID-19 pandemic, although its businesses were also the first to suffer from lockdowns and other measures to tackle the virus. The economy began to recover in the second quarter of 2020 and the growth rate climbed to 18.3% year-on-year from January to March. The country is aiming for GDP growth of more than 6% this year and has relaunched reforms of its financial sector, including stricter rules for the financial operations of its tech giants.
“Regulators may now follow this trend more closely to examine the structure of wealth management products and regulate the transparency of the structure,” said Iris Pang, Hong Kong-based chief China economist at ING Bank.
As of June 16, US $ 1 was equivalent to 6.40 yuan.