Chinese banks are engaged in a fundamental shift of their business model, as shadow banking activities are contracting and off-balance sheet loans are migrating back to banks’ formal loan books. Regulatory tightening is expected to hurt banks’ profit margins and overall asset growth, particularly at smaller regional banks. As bank loans return to their traditional role as the primary form of credit extension in China, the property sector and local governments in China’s interior provinces are vulnerable as credit migrates back toward China’s coasts and back onto banks’ balance sheets. Corporate credit spreads are likely to widen as more credit risks materialize among these borrowers.
