China’s new impetus to rein in its financial sector has been underway for more than three months. The effects are already being felt in the financial markets, impacting short-term borrowing rates and the global commodities market.
In late February, Guo Shuqing was appointed the new chairman of the China Banking Regulatory Commission (CBRC), China’s main banking regulator. Barely a month into his role, Guo issued a flurry of directives described by state-controlled Xinhua as a “strong supervisory storm.”
Guo, 60, is widely seen as a tough regulator willing to challenge financial heavyweights. His predecessor, Shang Fulin, was focused more on maintaining order and stability and did little to assert control over the financial sector, which has grown fat on China’s debt binge in recent years.
The CBRC’s new directives arrive as Chinese Communist Party leader Xi Jinping shifts his anti-corruption focus to the financial sector. Last month, Xiang Junbo, former head of the China Insurance Regulatory Commission, was placed under investigation. Sources close to Zhongnanhai—the headquarters of the Communist Party and the State Council—told The Epoch Times last month that there could be further housecleaning within China’s financial industry this year.
Several of the new policy directives from the CBRC aim to deleverage the country’s banking sector. Two main goals are to reduce shadow banking—an umbrella term for various high-yield products sold under unregulated conditions by banks, insurance companies, and other financial institutions—and to tighten credit.
Shadow Banking Targeted
Shadow banking and other off-balance-sheet credit activities fueled much of China’s recent debt growth, especially by regional and local banks. The biggest type of shadow banking is the sale of wealth management products issued by non-bank entities such as trusts, investment vehicles, or insurance companies, but often sold by banks.
Such products, which circumvent typical lending rules and do not sit on bank balance sheets, have been a critical income source for banks and often represent the only avenue of financing available for small businesses, local agencies, and ventures that cannot qualify for loans from big state-owned banks.
Off-balance-sheet wealth management products totaled 26 trillion yuan ($3.8 trillion) at the end of 2016, an increase of 30 percent from the previous year, according to data from the People’s Bank of China, China’s central bank.
In early February, China unveiled the first coordinated approach to regulating shadow banking. The People’s Bank, the CBRC, and regulators of the insurance and securities industries drafted a joint regulatory framework to tighten supervision of all investment products sold to retail and institutional investors.
This coordination is significant as “previous efforts to regulate the asset management industry have emanated from individual regulators and created opportunities for regulatory arbitrage,” said Moody’s Investors Service, in a Feb. 27 note. In other words, China’s fragmented regulatory framework often allowed banks to sell wealth management products that fall under the jurisdiction of a different regulator—with lower standards—than their underlying assets.
A few of the tools introduced by regulators this year include barring the sale of wealth management products derived from non-standard assets other than stocks, bond, and money-market securities, and applying a leverage limit across asset classes. One way banks had to boost the interest on wealth management products was to borrow money, and this risky practice will now be curbed.
Short-Term Liquidity Squeeze
Regulators are also targeting the loosely regulated interbank market that allows banks to lend to each other.
The People’s Bank is achieving this by reducing the amount of liquidity available to banks. After skipping open-market operations (through which the central bank buys or sells government securities) on May 2, it did not renew the 230 billion yuan lending facility, which matured on May 3. Overall, the People’s Bank injected a net 10 billion yuan ($1.5 billion) into the market, a minuscule amount compared to past weeks.
The recent tightening moves have pushed up short-term borrowing rates. The overnight Shanghai Interbank Offered Rate (Shibor) reached 2.83 percent, while the seven-day Shibor reached 2.92 percent on May 5. Those were the highest rates since April 2015.
“We expect liquidity to remain volatile and financial deleveraging to continue, with more ’mini hikes’ in market rates and tighter new regulations,” wrote Deutsche Bank, in a March note.
Slowing Economic Growth
The higher funding costs could have real-world economic implications, such as lower availability of credit for businesses and, ultimately, slower GDP growth.
But it’s likely that the official 6.9 percent GDP growth in the first quarter—above most economic forecasts—has given regulators room to curtail credit growth and still attain Beijing’s 2017 annual growth goal of 6.5 percent.
Chinese stocks have languished in recent weeks due to lowered expected future growth. The Shanghai Composite Index trailed other major global indices over the last 30 days, with a decline of 5.4 percent.
The global commodities market—especially sensitive to Chinese demand—has felt the biggest impact. Brent crude was down almost 11 percent over the 30 days ending May 5. Prices of iron ore, copper, and coal futures were also lower over the same period. Iron ore traded on the Dalian Commodity Exchange and hot-rolled coil and steel rebar traded on the Shanghai Futures Exchange plunged by their daily respective maximum allowed rates on May 3.
More regulatory clampdown may be on the horizon. A new rumor is circulating that Guo, the hawkish head of the CBRC, may soon take over as chief of a newly formed super-regulator, the amalgamation of current regulators for the banking, securities, and insurance industries, according to the South China Morning Post.
For the Chinese financial industry and global investors, all signs point to further market volatility ahead.
