China Targets Bank Transparency with Latest Regulations

Proshare

Friday, January 19, 2018 /11:15AM /Fitch Ratings 

Regulatory tightening in China's financial sector is likely to remain a priority for 2018 following a series of recent notices that aim to close loopholes and increase authorities' control over leverage, which is a key risk to financial stability, says Fitch Ratings. Regulatory headwinds look likely to hold back bank earnings again this year.
 

The latest moves could help to contain contagion risks associated with high interconnectivity, and to address governance and transparency weaknesses that weigh on Chinese banks' Viability Ratings. However, there is little sign that regulatory tightening is so far reducing overall system leverage.
 

The notices released by the China Banking Regulatory Commission appear to take a more holistic regulatory approach that pushes banks to take a deeper look at their total credit exposure and better account for underlying risks. For example, a consultation has been put forward to broaden the scope of caps on banks' large exposures, consistent with the Basel Committee framework. The consultation, if passed, would come into effect on 1 July and banks would need to comply with the limits on large exposures by end-2018.

Under the proposals, loan exposure to a single name will still be capped at 10% of Tier 1 capital, but the cap will extend to include non-loan credit. Single-name total credit exposure will be capped at 15% of Tier 1 capital, while single-group exposure will be capped at 20% of Tier 1 capital, and include connected counterparties that are controlled or are economically dependent on the same group.
 

There will also be a 15% cap on exposure to unidentified counterparties in structured products, which will force banks to adopt a look-through approach and identify the underlying assets and counterparties embedded in these products.
 

Single-group limits will also apply to interbank exposures for the first time. The cap will be set at 100% of Tier 1 capital from June 2019, and phased reductions over the next three years will take it to 25% by end-2021, consistent with the Basel requirements. We believe some mid-tier banks would currently fail to meet these interbank exposure rules, although the three-year grace period should allow most to comply. Banks designated as global systemically important banks (G-SIBs) will have their credit exposure to other G-SIBs capped at 15% of Tier 1 capital.
 

A separate notice continues the crackdown on entrusted loans, with a particular emphasis on ensuring that proceeds from entrusted loans are not used to buy financial assets or extend loans to restricted sectors, such as those with overcapacity, real estate and local government financing vehicles. Entrusted loans are inter-company lending in which banks act only as intermediaries. Outstanding entrusted loans increased by 6% in 2017 and account for 8% of total social financing (TSF), up from around 3% in the early 2000s.
 

Scrutiny on shareholders has also been increased to avoid excessive single-investor influence over bank operations and tackle problems with related-party transactions. Clarity over ultimate shareholders may also improve accountability and corporate governance.
 

These latest moves are a step towards improving transparency and addressing the adequacy of banks' risk-weighting and provisioning levels. They are also in keeping with efforts since early 2017 to contain riskier types of lending - there is evidence that interbank activity and entrusted investment exposure (i.e. investments in asset- or wealth-management products managed by other financial institutions) are now contracting, although some of that may have migrated back into bank loans.
 

Official TSF growth has not slowed notably and at 12% in 2017 is still running faster than nominal GDP growth, which means that overall system deleveraging is still not happening. Genuine deleveraging would hurt near-term economic growth and banks' asset quality, but there are so far no sign of the effects.

 Proshare Nigeria Pvt. Ltd.

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