Playing Whack-A-Mole With China’s Banks

In newly released regulations, China’s banking authorities have taken aim at a subset of financial assets whose origin, value, and underlying risk remain obscured to regulators. Many of these may be loans, but banks have taken efforts to re-characterize these assets on balance sheets, or found ways to place them off balance sheets, in order to avoid capital and provisioning requirements and generate higher returns.

The broader problem Chinese authorities are trying to address is systemic in nature, and extends beyond any individual classification of credit assets or form of lending. Banks are continuing to expand their balance sheets aggressively, despite rising credit risks from a slowing economy, by increasing claims on other institutions, including other banks, which are considered government-backed or “too big to fail.” This widespread moral hazard throughout the Chinese financial system has been a key condition for the continued growth of banking assets, credit, and consequently financial risks as this process has facilitated increasingly speculative activity, particularly as interest rates in the economy have fallen.

A selective review of banks’ 2015 results, including the Big Four banks and six smaller banks, shows asset creation last year was increasingly concentrated in these assets, often characterized as “investment securities and other financial assets.” Most notably, small banks post faster growth in both on- and off-balance sheet forms of “shadow” banking. Political factors continue to drive banks’ expansion despite rising credit risks and funding costs, as local governments pressure smaller banks to deliver conditions suitable to maintain growth.

Posted August 1, 2017
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