Will the proposed new rules targeting at shadow banking activities in China be effective in the long-run?

Bloomberg News Online reported on January 07, 2014 that there have been talks among members of China’s cabinet that new regulations are currently being worked out to ensure the stability of the overall banking system in the country, including proposed new curbs targeting at ‘shadow’ banking activities (borrowing/lending outside of the financial system).

Readers might recall that back in late June 2013, there were various episodes that led to the spike in the interbank market funds rate, as measured by the Shanghai Interbank Lending Offer Rate (SHIBOR). The sudden spikes in interbank lending rates led to approximately two weeks of extreme volatilities in the global financial markets, before the country’s central bank, the People’s Bank of China (PBOC) finally stepped in to ease the anxieties among many market participants. There were several reasons offered by many traders and investors regarding the inaction by the PBOC to intervene in a timely manner, however, the one major issue that gave rise to the delayed intervention was the PBOC’s firm stance regarding the various aggressive moves made by several Chinese financial institutions to allow the so-called ‘shadow’ banking system to thrive, thus overriding some of the jurisdiction, or policing oversight that used to come under the purview of the various Chinese securities, and banking regulators. The PBOC has long been targeting the ‘shadow’ banking activities as banks and other financial institutions have in the past taken advantage of the relaxed standards, and adopted several risk-taking initiatives that do not seem to conform the spirit of the existing regulations regarding prudence, and have instead chosen to take on more risks that do not seem to benefit shareholders, and the larger Chinese public.

According to a quote made during a Channelnewsasia interview broadcast aired on January 06, 2013 with Mr. Samuel Tsien, the current Chief Executive Officer (CEO) of one of Singapore’s oldest banks, the Overseas-Chinese Banking Corporation (OCBC) Limited and currently in talks to acquire a majority stake in Hong Kong’s Wing Han Bank, Limited, when he was asked about his perspectives regarding the ‘shadow’ banking system in China, he replied by saying that the Chinese government did the right thing in curbing such activities that misallocated resources to the unproductive sectors of the economy, resulting in market distortions that might come back to ‘haunt’ the financial institutions that are responsible for creating such market distortions, and lack of alignment to the shareholders and to a large extent, the wider Chinese public interests.

Bloomberg News reported that based on the preliminary text that they have been obtained from various undisclosed sources, the newly proposed regulations include a ban on transactions are designed to avoid regulations, such as moving interbank loans off balance sheet to reduce the banks’ reported lending volumes. However, the proposed regulations are still in work-in-progress mode and a proposed announcement is expected to be made by the Chinese government on what the actual rules are in due course. The Chinese authorities hope that by allowing greater transparencies in the financial system, market confidence can be restored. On this issue, it is still highly controversial whether ‘shadow’ banking activities should be outlawed completely, as it provides entrepreneurs and start-ups with ample flexibilities, and financial resources necessary to sustain the overall business. However, with the eventual crack-down on ‘shadow’ banking activities, it is expected to give rise to higher inflation expectations due to the amount of search expenses incurred through the supply channel used to procure the resources necessary to satisfy customers’ demands.

Based on the January 07, 2014 Bloomberg News article, the new rules also covers enforcement actions to be taken such as ban on using third parties to evade restrictions on lending directly to certain borrowers. Other target areas include the wealth management industry in China, where new rules are currently being worked out by regulators from the China Banking Regulatory Commission, including the ban on marketing wealth management products that violate regulations, as well as exposing it to reckless trust businesses, financial guarantees and microfinance. Bloomberg News also reported that based on a recent Chinese audit of local governments, the findings revealed that local governments have resorted to adopt risk-taking behaviours that seeks to increase their risk exposures to such products that appeared to be what Mr. Tsien of OCBC Bank who described during the January 06 Channelnewsasia broadcast interview as unproductive activities that led to market distortions.

Critics have warned that despite the widespread support to rein in on the ‘shadow’ banking system in China, there needs to be a focus on measures that seek to improve the overall structure of the economy such as adopting reasonably good corporate governance standards that do not undermine the shareholder and public interests. There are also those, I believe, who generally are in favour on the whole regarding the new rulings could comprise of two groups such as those that advocate responsible consumer rights to be maintained at most times, and shareholder activists seeking for timely government action to curb the risk-taking behaviours that could threaten China’s overall economic policy goals, and maintaining the sustainability of the overall economic growth momentum in China going forward.

About Hock Meng Tay - Chief Editor, Asia-Pacific Region

Hock Meng Tay, CAIA has written 181 post in this blog.

Chief Editor, Asia-Pacific Region Hock Meng Tay is a CAIA holder and is currently taking CFA qualification. He has over 10 years of experience working as research associate in several investment companies.He is an expert in financial analysis and has published research reports in his current role. He obtained his Masters of Business Administration in Integrated Management and Masters of Arts in Economics while serving his internship in Starsource Inc