ISCA- UOB Quarterly Economic Updates for CFOs

Transcription

1 ISCA- UOB Quarterly Economic Updates for CFOs 1

2 China: Shadow Banking SUAN Teck Kin, CFA UOB Economic-Treasury Research ISCA-UOB Quarterly Economic Updates for CFOs 24 April 2014 Disclaimer This presentation was prepared for informational purposes only and shall not be copied, or relied upon by any other person for whatever purpose. The information provided herein is based on publicly available information. Although believed to be reliable, UOB Group makes no representation as to the accuracy or completeness. This presentation must be viewed in conjunction with the oral presentation provided by UOB and/or its officially appointed distributors/agents. Nothing in this presentation constitutes accounting, legal, regulatory, tax or other advice. The reader(s) of this document should consult his/their own professional advisors about the issues discussed herein. This presentation is not intended as an offer or solicitation with respect to the purchase or sale of any investment product and nothing herein should be construed as a recommendation to transact in any investment product. To invest, please refer to the prospectus (where applicable) for details. 2

3 China Shadow Banking Executive Summary Shadow banking Sharp increases in non-bank and informal credit activities in China since 2008 Financing chain involves borrowers, non-bank institutions, banks, and depositors systemic concerns ( too big to fail?) Size unknown: est. RMB5 trillion to RMB50 trillion (~9% to 88% of China s GDP, or 3.5% to 35% of total banking assets) Central government has the ability to absorb losses, but costs to economy and financial system? 3

4 China: Shadow Banking What Is It? How Big Is the Scale? Why Did It Come About? Risks and Implications: How Will It End? 4

5 Shadow Banking: What Do We Know? Source: Global Shadow Banking Monitoring Report 2013, p 6 5

6 Shadow Banking: What Do We Know? In China s context Document 107 clarified definition of shadow banking into 3 types 1. No operating licenses and unregulated, e.g. internet finance companies 2. No operating licenses and only partially regulated, e.g credit guarantee companies 3. Licensed but face inadequate regulation, e.g. money-market funds; asset securitization, etc 6

7 Shadow Banking: What Do We Know? A typical shadow bank transaction flow Source: Questionable Lending in China, NYT 1 July Lending-in-China.html?ref=global 7

8 Shadow Banking: What Do We Know? ICBC distributing China Credit Trust product... Source: 8

9 China: Shadow Banking What Is It? How Big Is the Scale? Why Did It Come About? Risks and Implications: How Will It End? 9

10 Shadow Banking: What Do We Know? Based on total social financing (TSF) data: 10

11 Shadow Banking: What Do We Know? Traditional bank loans still play a key role but non-bank intermediation rising rapidly since 2008 Source: UOB IR, PBOC 11

12 12 Shadow Banking: What Do We Know?

13 13 Shadow Banking: What Do We Know?

14 Estimated Size of China Shadow Banking Varies Some divergence in analysts estimates, due to different interpretation and some double-counting highlights issues surrounding transparency (quite common for emerging markets). But all in broad agreement that China s shadow banking is sizeable, ranging CNY35trn CNY50trn at end-2013 (62% 86% of GDP). Source: UOB IR compilation; Note: China s nominal GDP for 2013 was CNY56.9trn (USD9.4trn). Source: UOB IR, Various; Note: China s nominal GDP for 2013 was CNY55trn (USD9.3trn). 14

15 15 Shadow Banking: What Do We Know?

16 16 Shadow Banking: What Do We Know?

17 China: Shadow Banking What Is It? How Big Is the Scale? Why Did It Come About? Risks and Implications: How Will It End? 17

18 Shadow Banking: What Do We Know? Why the proliferation of shadow banking in China? Restrictions in the formal banking sector: - Bank loan quotas - Lending restrictions on certain sectors - Interest rate floors and ceilings - LD ratios - Reserve requirement ratios (RRR): 20% 18

19 Shadow Banking: What Do We Know? Why the proliferation of shadow banking in China? Landscape - Dominance of large state-owned commercial banks - Lack of financing channels - Lack of clear regulations or enforcement: power of regulation power of enforcement - Lack of domestic investment alternatives (other than equity and property markets) - Lack of international investment alternatives: closed capital account 19

20 Shadow Banking: What Do We Know? China s State Council Document 107 (107 号文 ) Media reports* noted document s release on regulation of shadow banking This is the highest profile guidelines on shadow banking... More related regulations are likely to be released later... Affirmed shadow banking s positive contribution but concerns about insufficient/ineffective regulation... Concerns about banks off-balance sheet activities and trust companies credit type business Not full blown crackdown, but to improve regulations, transparency of the sector *e.g. 中国影子银行监管新规雷霆出台 6 Jan 2014, Reuters 20

21 Challenging to Disentangle Financial Linkages Banks interconnected to their shadows, via credit & liquidity channels. Troubled trust products signal rising delinquency threats. Interbank-rate spikes highlight tight liquidity at some banks. Choosing between moral hazard vs contagion. Excess funds Intermediaries/Channels Borrowers Defaults Regulated Depositors Banks Low or no regulations Flight to quality Banks Businesses WMP investors Trust investors Low or no regulations Shadow flows Regulated flows WMPs Trust AUMs Other conduits Low or no regulations Businesses Government Household 21

22 What are the Risks of Shadow Banking to China? Contagion risks Borrowers in shadow banking market often remain direct/indirect debtors of regular banking sector Banks are exposed to credit losses when lending to companies participating in shadow banking Any default in the credit chain weakens original borrowers repayment capability, which translates to asset quality issues for banks Entities may also rely on shadow banking market to repay bank loans; credit squeeze in shadow banking market will similarly impair banks assets Banking system risk WMPs are typically short-term products funding long-term assets; banks increasingly relying on interbank liquidity to bridge funding gap between WMP redemption and reissuance Exposed to disruptions in the interbank market Interbank lending has also funded shadow banking activities through other complex deal structures, contributing to build-up of systemic risks Risk of runs on products or institutions are heightened by opaque underwriting standards; may result in widespread losses or liquidity stress for banking system 22

23 China: Shadow Banking What Is It? How Big Is the Scale? Why Did It Come About? Risks and Implications: How Will It End? 23

24 Potential Risks from Shadow Banking Indirect reputational, legal liability and regulatory exposure Banks are also exposed to indirect losses when WMPs they have distributed turned sour, even if they are only involved in non-underwriting aspects of the products May be pressured to bail out investors of these WMPs and assume losses Impact on wider economy Loss-making WMPs may impose significant losses on investors, which include depositors, wealthy individuals, corporates and banks Segments such as SMEs, property developers etc. have been especially reliant on shadow banking market for financing; drying up of funds in the shadow banking market may see many of these companies folding up Interconnectedness between entities in the real sector has also increased as a result of shadow banking activities, exacerbating potential impact on wider economy Impact will reverberate through the real economy in the form of cutbacks in consumption and investments, as well as individual and corporate bankruptcies A deterioration of China s economy will negatively impact countries which rely heavily on China for trade, finance and tourism, e.g. Singapore, Taiwan & Korea 24

25 Potential Risks from Shadow Banking Reputational risk: Flight-to-safety scenario cannot be ruled out, as evidenced by the CCT saga. Shadow-banking products distributed by banks may be perceived to be safe and guaranteed by banks. A large portion of investors are retail, and they may not be highly sophisticated, despite the CNY1m minimum denomination for trust products. Shadow banking could be sensitive to a confidence crisis, and destabilize the system Liquidity risk: Shadow-banking funds have shorter tenors than underlying assets. Eligibility of underlying assets as collateral is questionable during a liquidity crunch. Rising WMP issuance (especially at mid-sized banks) may means a shadow-banking crisis could have spillover effects on the broader banking sector. Source: Fitch Big 4 state banks 25

26 Shadow Banking: How Will It End? 26

27 Crisis period Hypothetical Banking Recap Seems Manageable Recapitalisation bill for China banking sector would mean additional debt for the government, ranging from 20% 30% of GDP. Assumptions: Increase in problematic assets to emerge over a period of time. Impairment to emanate from various on-balance-sheet assets & shadow exposures. Zero recovery rate. Banking-sector recapitalisation bill Problematic exposures (% of assets + shadow) (% of GDP) 8% 10% 12% 14% 16% 1 year years years years Memo: At end-june 2013 Recap Target: Tier 1 CAR: 9.9% Tier 1 CAR: 10.0% PPOP/Assets: 2.2% Banking assets: CNY144.2trn % of shadow assets: 30% RWAs CNY71.5trn GDP: CNY56.9trn Case Study - China banking crisis (1990s) At the end of 1998, China s 4 large state-owned commercial banks, accounting for 68% of banking system assets, were deemed insolvent. Banking system s NPL ratio was estimated at 20% in The government undertook significant measures to restructure and bail out the banks. By end of 2005, commercial banks NPL ratio dropped to below 10%. The cost of a potential clean up of the banking system was estimated to have reached CNY trn (47 18% of 2002 GDP). In this case, the government has demonstrated its willingness and capability to funnel massive fiscal reserves to avert a crisis. If history is any guide, the country will not slip into a full-blown crisis as long as the government is willing to foot the bill. Source: Systemic Banking Crises: A New Database, IMF, Nov 2008 WP/08/224 Source: UOB Investor Relations calculations Source: UOB IR, Fitch 27

28 Regulations Relating to Shadow Banking China s Cabinet imposed new controls on shadow-banking industry in Jan The rules include a ban on transactions designed to avoid regulations, such as moving interbank loans off balance sheets to reduce reported levels of lending. CBRC guidance in Mar 2013 on Chinese banks include: Cap on WMPs that invest in non-standard debt assets at 35% of a bank s total WMP balance, or 4% of its total assets Ban on the practice of offering guarantees or repurchase agreements on those of their WMPs that invest in non-standard debt assets or equity assets Separate accounting books for individual products, and improve information disclosure to investors Rules preventing trading between banks' proprietary accounts and WMPs held for their clients went in to effect in May Capital requirements for trust companies, with AUM/equity capped at 50x. The ratio stood at 44x at end-sep 2013 vs 24x at end

29 Patience Required to See Reforms Through Local authorities will continue to play the balancing act, i.e. to allow shadow banking to develop/evolve, while staying mindful of potential threats. Systemic risks likely to stay elevated in the near term. Regulatory efforts have largely been reactive, but may eventually catch up. Data transparency also poses a challenge for policy makers. Deleveraging takes time, and an overly-proactive or purist regulatory approach may induce hard landing for the Chinese economy, which has largely been credit-fuelled. Local authorities have high willingness to protect financial-sector stability, while allowing regulations to gradually take effect over time. Confidence broadly restore after PBOC s interbank intervention and CCT bailout. Other evidences of growing links among banks, and between the banking sector and its shadow. 29

30 Conclusion China s shadow banking has grown rapidly since 2008, and has become fairly sizeable by emerging market standards. Risks of contagion effect on broader banking sector and economy through liquidity and credit channels. Recent developments reinforce market consensus of the government s strong willingness to maintain financial-sector stability in the near to medium term. In the long run, it may gradually allow financial institutions of lower systemic importance to fail, to minimise moral hazard implications. Unwinding the build-up in imbalances is a delicate and long-drawn process, at a time when the Chinese economy is decelerating. Moreover, other conflicting objectives may influence the form and pace of banking reforms and regulations. The Chinese government has the fiscal capacity absorb potential liabilities in the event of a systemic shock. 30

31 31 Appendix

32 Risk Profile of Shadow Banking Products Others have low to medium levels of credit risk Entrusted loans: loans between corporates with banks or finance companies acting as payment agents; borrowers/lenders often belong to same corporate group Undiscounted bankers acceptances: typically trade related but rapid growth suggests that at least a portion serves as less formal/transparent form of credit Loans by finance companies: primarily to intra-group member subsidiaries; only large conglomerates qualified to set up finance companies Asset-backed bonds: securitizations by banks, asset management companies and trust companies with official approvals and quotas from regulators; underlying assets typically bank loans Loans by financial leasing companies and pawn shops: loans typically secured by collateral and not necessarily more risky than bank loans 32

33 What factors have fueled rapid growth of this sector? Regulatory arbitrage Control on interest rates. Cap on bank deposit and loan rates, incentivizing banks to package high-yield WMPs for yield seeking customers that often fund trust loans Loan-to-deposit ratio. To meet 75% limit, banks can arrange WMPs to attract funds that are temporarily swapped to bank deposits, with products being timed to mature at quarterends Capital adequacy management & loan loss reserve requirements. Banks can repackage direct exposures in to trust products that they finance via repurchase agreements in the inter-bank market; interbank exposures may require lower risk weights/reserves Credit rationing Policy controls on funding to property sector/lgfvs & other sectors. Tightening availability of bank loans to these sectors have driven borrowers to informal channels Loan quotas. Banks face government-determined yearly and monthly loan quotas Financial exclusion Generally riskier borrowers not qualified for bank loans such as SMEs often seek funding outside formal banking system 33

34 Local Government Debt: What Do We Know? Latest Audit National Audit Office released latest details on 30 Dec 2013 Local government debt has risen +13% in 6 months, to RMB17.9 trillion end-jun 2013; vs. RMB10.7 trillion end-2010 Debt size increased 67% from 2010 Complete NAO report on government debt audit outcome (30 Dec 2013): 34

35 35 Local Government Debt: What Do We Know?

36 Disclaimers This presentation was prepared for informational purposes only and shall not be copied, or relied upon by any other person for whatever purpose. This presentation must be viewed in conjunction with the oral presentation provided by UOB and/or its officially appointed distributors/agents. Nothing in this presentation constitutes accounting, legal, regulatory, tax or other advice. The reader(s) of this document should consult his/their own professional advisors about the issues discussed herein. This presentation is not intended as an offer or solicitation with respect to the purchase or sale of any investment product and nothing herein should be construed as a recommendation to transact in any investment product. To invest, please refer to the prospectus (where applicable) for details. 36

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