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China's shadow banking sector may shrink further as economy rebounds

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China's shadow banking sector may shrink further as economy rebounds

Less creditworthy borrowers in China who used to lean on nonbank lending are set to remain under funding pressure in the medium term, analysts say, as the nation relies more on formal bank loans to reboot its pandemic-hit economy in order to prevent risk in the shadow banking system from flaring up again as in past recovery cycles.

As of end-September, core shadow banking assets, which include outstanding entrusted loans, trust loans and undiscounted bankers' acceptances, totaled 22.06 trillion yuan, down 2.8% from a year earlier, according to data from the People's Bank of China. September's contraction rate, however, was the lowest since the year-over-year decline of 2.31% in July 2018.

"We believe that the government will prioritize financial stability [...] rather than a headline growth number," Yong Hong Tan, portfolio manager at Eastspring Investments, told S&P Global Market Intelligence.

"Given the de-emphasis of a headline GDP growth target, it is unlikely shadow banking will be allowed to grow again and formal bank lending will continue to form the bulk of new credit lending in China as banks continue to provide financial support to businesses and investments," he said.

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Different approach

China's economy has rebounded from contraction earlier this year and is on track for full-year growth. The GDP of the world's second-largest nation increased by 0.7% over the first three quarters of 2020 from a year ago, compared with a 1.6% decline in the first half.

According to PBOC data, total outstanding yuan loans at Chinese financial institutions hit a record high of 169 trillion yuan in the quarter ending Sept. 30, driven by the government's call to lend more aggressively to the pandemic-hit economy.

"As banks increase lending quota for [small and medium enterprises] which used to borrow from shadow banking channels, we expect banks loan growth would continue to outpace total social financing growth," said Cindy Wang, an analyst at DBS Group Research. She added that shadow banking assets are likely to contract by single digits on a year-over-year basis until shadow banking risk subsides further.

Beijing has so far unwound very few measures that were put in place in 2017 and 2018 to contain the financial risk of the once fast-growing nonbank lenders, especially following high-profile defaults of trust companies such as Anxin Trust Co. Ltd. Major easing measures include postponing the execution of more stringent rules on asset management by one year to 2021.

Shrinking sizes

Among the core shadow banking activities, trust loans have been declining more quickly since the beginning of 2020, while entrusted loans contracted at slower rates and undiscounted bankers' acceptances rebounded compared to previous months.

In September, trust loans declined 8.5% to 7 trillion yuan from a year earlier, the biggest drop since the 8.6% year-over-year fall in March 2019, and entrusted loans shrank 5.2% in September from a year earlier.

Tan expects trust lending activities will remain hampered by recent defaults of several trust companies, the deterioration in trust asset quality, and the increasing risk aversion to weaker corporations amid economic uncertainty.

DBS' Wang added: "As banks are more willing to lend money to SMEs through supply chain financing or collateral loans with cheaper yield helped by policy supports, corporates prefer to borrow from banks instead of shadow banking channels due to cheaper funding costs.

"The trend would continue in 2021 given overall liquidity in the banking system is ample."

In contrast, undiscounted bankers' acceptances rose by 18.8%, the highest since October 2017.

"The rebound of undiscounted bank acceptance bills, yet the decrease in the discount bills on banks' balance sheet, reflect that corporates have substantive business activities with bills demand for transactions and payment purpose in 3Q20," Wang said. "We don't expect undiscounted bank acceptance bills would continue to grow strongly entering in 2021 as regulators remain to clap down shadow banking financing."

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More contraction expected

China's shadow banking industry is likely to shrink further in 2021 as regulators continue to introduce restrictions for the sector. In August, China's Supreme Court slashed the legally protected ceiling of informal lending rate to promote a healthy and stable development of the private lending sector.

"The Supreme Court's lowering of interest rates on informal lending, including for microcredit, pawnshop loans and online peer-to-peer lending will close off an important financing channel for weaker companies as it makes it unprofitable for lenders," said Eastspring's Tan. "The government is getting stricter in controlling leverage in the property sector and the curbing of trust financing is one of the ways to achieve this in our view."

The China Banking and Insurance Regulatory Commission had told some trust companies to stop financing property developers that did not have all necessary licenses or met requirements on shareholders and capital, Caixin reported in July 2019. Some leading trust companies canceled trust products that planned to raise funds for property investments, the report said.

Even so, demand from borrowers who are not eligible to request loans from banks is likely to sustain throughout 2021, as China has delayed the implementation of more stringent rules on asset management from this year.

"Once banks' wealth management products [are] redesigned ... the risks from shadow banking should be reduced and the overall financial market would be more healthy."

As of Nov. 4, US$1 was equivalent to 6.66 Chinese yuan.