China Looks for a Savior in the Shadows
(Bloomberg Opinion) -- China’s central bank is stretching its arms far and wide to stem convulsions in the real economy. In the process, it’s lending legitimacy to financial firms that have long operated in the shadows.
Beijing has invited non-bank financial institutions to play a larger and more formal role in the aftermath of the first regulatory takeover of a commercial lender in two decades. Interbank rates have ballooned since the seizure of Baoshang Bank in late May, raising funding costs for financial companies. This week, the central bank asked its biggest state-owned banks to support large brokerages such as Citic Securities Co., Huatai Securities Co. and China International Capital Corp.
As a cash crunch looms, it’s worth asking why the central bank suddenly cares about brokers’ funding channels. Citic Securities, for instance, has only 673 billion yuan ($93 billion) in assets, in line with a mid-size regional bank. It’s also questionable whether brokers deserve bigger credit lines, considering their aggressive over-the-counter margin financing helped engineer the stock market’s spectacular boom and bust four years ago.
The simple answer is that brokers, alongside regional banks, have been major suppliers of credit to China’s companies. Non-bank financials, along with official lenders, have created close to 30 trillion yuan, or about $4 trillion, worth of shadow credit that’s gone into the real economy. Asset management products actively managed by the brokers alone came to 3.2 trillion yuan.
In theory, securities firms are primarily in the business of helping clients trade stocks and bonds. In China, they have become proprietary traders, which in turn use their balance sheets to supply credit to large swaths of the private sector. Their asset management businesses warehouse non-standard credit assets, typically off-balance-sheet loans to companies. At the end of 2018, assets under management for the top 11 brokers totaled 12.7 trillion yuan.(1)
When money is tight, company founders often pledge their shareholdings in exchange for loans from securities firms. This is a unique feature among China’s brokers, with trillions of yuan of such loans outstanding. Citic Securities, for instance, expanded this business to 25.9% of its total equity at the end of 2018, while smaller brokers such as Everbright Securities Co. more than doubled such loans since 2016.
Meanwhile, with its traditional tools not cutting it, the People’s Bank of China needs to find a way to plug the large hole that will be left by small regional banks after the Baoshang takeover. China has about 4,000 regional lenders accounting for 32% of the commercial banking system. They penetrate deep into the private sector and into economically weak provinces where major commercial lenders such as Bank of China Ltd. are largely absent.
Sales of negotiable certificates of deposits – a key source of funding for smaller banks – plunged after the PBOC declined to guarantee 100% of Baoshang’s liabilities. That will cause their balance sheets to shrink and in turn impair their ability to extend loans to companies.
Other risks are emerging. Regional banks are big creditors to securities firms. If they can’t fund themselves, they won’t roll over credit to non-bank financials either. Last week, Shanghai Haitong Securities Asset Management Co. said it didn’t default on any bond repurchase agreements in an attempt to calm jittery traders.
China has been through this before. In 2013, overnight rates jumped to as much as 30% as small banks got caught in a duration mismatch between their assets and liabilities. The PBOC eventually pumped in liquidity to bring down rates. That crisis exposed the central bank’s lack of tools and will to clamp down on shadow financing, and ended up spurring more such activity. The 2013 crisis entrenched moral hazard rather than breaking it, the Center for Strategic & International Studies said in a report last October.
This time, it’s even worse. The offenders are now being recruited as saviors.
(1) In the U.S., investment banks have been strongly discouraged from such balance-sheet lending under the Volcker Rule that was adopted after the global financial crisis.
To contact the authors of this story: Shuli Ren at firstname.lastname@example.orgAnjani Trivedi at email@example.com
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Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.
Anjani Trivedi is a Bloomberg Opinion columnist covering industrial companies in Asia. She previously worked for the Wall Street Journal.
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