China aims to fight growing risks in its financial sector with restrictions on shadow banking assets and interbank lending. But a sudden reduction of liquidity could increase rather than reduce the risk of a financial panic and dampen growth.
Under its new chairman Guo Shuqing, the China Banking Regulatory Commission (CRBC) has rolled out a series of measures to slow down the rapid rise of China’s shadow banking assets. The concern is that these unregulated assets could trigger a financial panic. But a sudden reduction in shadow banking assets could actually cause, rather than prevent, a financial panic and it could also trigger a substantial reduction of growth. Regulators have recently displayed much more caution in implementing new regulations.
Shadow banking assets serve the important functions of rolling forward risky bank assets and allowing banks to lend more. They are loans and other credit assets that banks have removed from their balance sheets and placed into vehicles such as wealth management products (WMPs), structured by investment banking divisions of Chinese banks, or asset management plans (AMPs), structured by brokers. According to recent CBRC disclosures, the total WMP outstanding is over 29 trillion RMB, or around 4 trillion USD. AMPs managed by brokers and their subsidiaries can be as high as 30 trillion RMB, or over 4 trillion USD. Since WMPs and AMPs often invest in each other, the total amount of underlying assets is likely much smaller than the two combined, but it is still likely that they net over 25 trillion RMB. This would be equivalent to 20 percent of all loans outstanding in the banking system.
New credit financed government stimulus
Why did shadow-banking assets grow from nearly zero prior to 2008 to such gargantuan size in less than ten years? In essence, banks created a massive pool of new credit to finance the 2008-2010 stimulus. First, banks financed many projects, which did not generate returns, thus making these loans non-performing. In order to prevent a wave of non-performing loans (NPL), they needed a way to evergreen these loans.