With 10-to-1 Leverage, Shadow Banks Fuel China's Stock Boom

(Bloomberg) -- Eager to pile into the world’s most-volatile major stock market with 10-to-1 leverage? China’s shadow bankers are happy to help -- and that has the nation’s policy makers worried.

Just hours after China’s CSI 300 Index notched a 6 percent surge on Monday -- its biggest gain in more than three years -- the country’s securities regulator warned of a rise in unregulated margin debt and asked brokerages to increase monitoring for abnormal trades. The China Securities Regulatory Commission’s statement followed a pickup in advertising by margin-finance platforms, which operate with little to no supervision and offer far more leverage than the country’s regulated securities firms.

While margin debt in China is much lower today than when it helped precipitate a market collapse in 2015, investors are boosting leverage quickly as they chase a rally that added more than $1 trillion to stock values since the start of 2019. The worry is that a sudden reversal would force leveraged traders to sell, exacerbating volatility in a market that posted bigger swings than any of its peers over the past 30 days. That prospect may unnerve Chinese policy makers, who have a history of trying to protect the nation’s 147 million individual investors from outsized losses.

“Whether the recent unregulated financing will mirror that of 2015 hinges on the attitude of policy makers,” said Deng Wenyuan, a Suzhou-based analyst at SooChow Securities Co. “I think they have learned a good lesson from the past.”

Many Chinese margin-finance firms tout their services through phone calls, text messages and promotions in chat rooms. One such platform, called Dingniudai, allows investors with 5 million yuan ($747,000) of capital to borrow 50 million yuan for stock trading, charging a monthly interest rate of 1.5 percent.

The 10-to-1 leverage ratio compares with a limit of 1-to-1 at regulated brokerages. More debt means bigger gains for investors when stocks rise, but steeper losses when they fall.

A hotline representative at Dingniudai said the platform has stopped accepting new investors after using all its capital available for lending this month. Other platforms are still soliciting clients, with some offering zero interest rates for first-time users and cash rebates to traders who refer their friends.

Margin-finance platforms last saw a surge in popularity in 2014 and early 2015, during a boom that added nearly $7 trillion of market value to Chinese stocks in less than 12 months. After a CSRC crackdown and a tumble in client demand in the wake of China’s market crash, the platforms retrenched.

Their resurgence has echoed a rebound in regulated margin financing, which at the start of February was at its lowest level since 2014. The outstanding balance of margin debt on the Shanghai exchange climbed for an 11th straight trading session on Monday, which saw the biggest daily surge since November 2015.

Large-cap Chinese stocks fell on Tuesday, with the CSI 300 Index losing 1.2 percent.

©2019 Bloomberg L.P.