China May Ease Shadow-Bank Crackdown to Bolster Slowing Economy

(Bloomberg) -- The virus that’s put China’s economic recovery at risk may ease a crackdown on the shadow banking market, which has shrunk by $1.7 trillion in the past three years.

As the virus spreads, the death count mounts and markets tumble, signs are emerging that policy makers are willing to take a gamble on stepping back from reining in the risky sector, giving the world’s second-biggest economy more breathing room.

“The Chinese government would only push for deleveraging on sunny days, not now,” said Ryan Lam, head of research at Shanghai Commercial Bank Ltd. in Hong Kong. “Debt isn’t a huge problem for them at the moment, so they would rather focus on dealing with the imminent problems.”

Regulators over the weekend agreed to extend a grace period for banks struggling to meet a deadline on the most stringent shadow banking curbs. The central bank has turned on the spigots to calm concerns, and banks are being directed to boost lending, lower rates and extend repayment schedules in stricken areas. At risk is China’s economic growth target, with the likes of Goldman Sachs Group Inc and UBS Group AG warning of a sharp slowdown.

During the boom years, shadow banking -- often loans masquerading as investment products -- were the lifeline of many small enterprises. The crackdown forced a record surge in bad loans, which now looks set to worsen with two-thirds of the economy under lock down.

A prolonged health emergency could cause banks’ bad loan ratios to triple, ballooning by as much as 5.6 trillion yuan ($800 billion), rating firm S&P Global predicted in a dire assessment on Tuesday.

Even before the deadly outbreak, signs were emerging that authorities were starting to take their foot off the neck of the shadow banking sector. What follows are five charts on how the crackdown had looked to be losing steam, the loopholes regulators have closed, as well as the casualties of the campaign.

Flattening Out

Shadow banking assets declined by 20% since the start of 2018 to about 50% of gross domestic product after a period of breakneck growth, according to Fitch Ratings. The debt rating firm estimates China had shed 11.5 trillion yuan ($1.7 trillion) in shadow loans since 2017, faster than it had expected, even as the pace of decline started to flatten out in the second half last year.

China May Ease Shadow-Bank Crackdown to Bolster Slowing Economy

Two key components of shadow banking include high-yield asset management products sold to the public and a web of leveraged lending between financial institutions. The outstanding value of wealth management products, most of which offered guaranteed returns, has barely increased since 2017. Products assuring returns were meant to stop by December, but the regulator has now allowed an extension, giving banks more time to transition customers.

Bank borrowings by financial firms such as investment funds and securities brokers saw a slight uptick in late 2019 after declining in the past two years.

China May Ease Shadow-Bank Crackdown to Bolster Slowing Economy

Regulators have closed loopholes. When they choked off high-yielding deposits, banks initially boosted their issuance of structured deposits, many of them with embedded options. These derivative features allowed issuers to advertise higher yields, which were later subsidized by banks, bypassing rules prohibiting guaranteed returns.

Issuance of structured products have dropped in the most recent quarter, reaching back to to early 2018 levels as authorities barred some types of these deposits.

China May Ease Shadow-Bank Crackdown to Bolster Slowing Economy

With shadow financing squeezed, attracting real deposits has become more important. That in turn puts upward pressure on money-market rates, increasing the strain on borrowers. China’s credit markets are already sending distress signals. Defaults hit records in 2018 and 2019 as borrowers struggled to refinance debt.

Authorities in Beijing have directed its biggest banks to pick up the slack and lend more to small companies, with those affected by the coronavirus the target of the most recent measures. State-owned enterprises have also been asked to help with equity and debt financing.

China May Ease Shadow-Bank Crackdown to Bolster Slowing Economy

Among the most scrutinized when it comes to financial risk are China’s thousands of online lenders, which attracted upwards of 50 million investors at its peak, more than the populations of New York state and Texas combined. Now, the industry is facing existential problems with even the largest players ordered to exit the business. That is one area unlikely to enjoy any meaningful recovery.

China May Ease Shadow-Bank Crackdown to Bolster Slowing Economy

But as China ramps up easing, it must guard against the dangerous build-up of leverage that forced the last crackdown.

“Deleveraging may be put on the backburner if the health outbreak worsens,” S&P analysts led by Ming Tan wrote in a note this week. A widening gap between economic growth and credit expansion “could have longer-term consequences on financial stability if it isn’t carefully managed.”

©2020 Bloomberg L.P.

BQ Install

Bloomberg Quint

Add BloombergQuint App to Home screen.