China Renews Bid to Curb Shadow Banking

China’s cabinet has drafted a new regulatory framework to tighten oversight of the rapidly-growing shadow banking services sector and risky off-balance sheet lending. The move is regarded a response to mitigate growing financial risk caused by the country’s rapidly mounting debt levels.

A copy of the State Council’s Document 107, which was drawn up nearly four weeks ago but has only now become public, calls for tighter regulation of Chinese banks’ off-balance-sheet lending and states that trust companies – the biggest non-bank players in the shadow banking sector – should return to their original role of asset managers and not engage in ‘credit-type’ business.

Although issued by the council, Document 107 is thought to have been drafted jointly by the People’s Bank of China (PBOC) the country’s central bank and the banking, securities and insurance regulatory commissions, signalling the government’s wish to adopt a more coordinated approach towards financial regulation.

However, the document stops short of demanding a full-scale crackdown on the sector, indicating that the leadership recognises that shadow banking represents a key source of credit for the China’s economy but has also contributed to industrial overcapacity and
local governments’ rising debt levels
.

“The emergence of shadow banks is an inevitable result of financial development and innovation. As a complement to the traditional banking system, shadow banks play a positive role in serving the real economy and enriching investment channels for ordinary citizens,” Document 107 states.

It goes on to identify three categories of shadow banks, whose development will be monitored more closely in future – those with no operating licences, such as internet finance companies, currently exempt from to no regulations; those that do not hold licences and are partly regulated, such as credit-guaranteed companies; and those holding licences but not adequately regulated, such as money market funds (MMFs).

“At present, our country’s shadow banking risks are under control overall,” the document stated. “But as the 2008 global financial crisis demonstrated, shadow banking risks are complex and hidden, and vulnerabilities can emerge suddenly and spread easily causing systemic problems.”

A Delicate Balance

In recent months, the People’s Bank of China (PBOC) the country’s central bank and other regulators have been debating how to slow the increase in debt without seriously denting China’s economic growth. Last month premier Li Keqiang said while China would maintain a prudent monetary policy as well as ‘appropriate’ liquidity in 2014, he expected there would be reasonable growth in credit.

He did not indicate any planned crackdown on shadow banking, which began to grow rapidly in China four years ago as banks began running up against limits on expanding loans through traditional channels. As China does not yet regulate shadow banking as closely as traditional banking activities, shadow lenders often disclose little information on what they are investing in or how their loans are performing.

China’s financial system was previously dominated by banks, which represented more than 90% of funding in the economy. The recent rise of non-bank institutions, particularly trust companies, has radically transformed Chinese finance, with banks now providing no more than half of all new funding.

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