China’s Regulation of Its Shadow Banking Sector is Showing Some Results

Chinese authorities’ moves to dampen credit growth and liquidity conditions, as well as their efforts to regulate the nation’s shadow banking industry, appear to be having a modest effect in moderating the growth of wealth management.

"However, the authorities are also engaged in a delicate balance to ensure that tighter credit and liquidity conditions do not trigger financial instability," said Michael Taylor, a Moody's Investors Service managing director and chief credit officer for Asia Pacific, in a new report on the topic. "Tighter market liquidity is being partially offset by higher lending to the banking system by the People's Bank of China, while regulators are offering grace periods for the implementation of new policy guidelines.”

Borrowers are increasingly turning to formal bank lending, as well as lending by the relatively more highly regulated parts of the shadow banking sector, like trust companies, as regulation has tightened around shadow banking in general, analysts said. "The rotation of credit supply to these sources improves transparency and could increase the system's resilience in the face of unexpected shocks," said George Xu, a Moody's associate analyst. "However, it remains unclear whether credit from these sources will be sufficient to replace credit supplied by the shadow banking components that are now subject to closer regulatory scrutiny."

Refinancing risk is thus growing for borrowing businesses in China that have grown reliant on the shadow banking industry, including property developers, local government financing vehicles and state-owned enterprises in overcapacity industries, Moody’s said. The gap between overall credit growth in the Chinese shadow banking sector and the growth rate of nominal GDP has shortened in recent months. Also, the growth in credit assets like wealth management products has apparently slowed, thanks to regulation. “Moody's points out that the challenges associated with regulatory tightening are illustrated by a strong rebound in new negotiable certificates of deposit issuance and the increase in the banks' net claims on nonbank financial institutions, both indicators of continuing system interconnectedness,” the ratings agency said.

– Nicholas Stern, senior editor

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