* New loans surge in first quarter even as economy shrinks
* Move coincides with drop in interbank exposure
* Investors shift from trusts back to banks
By Lianting Tu
SINGAPORE, May 1 (IFR) - Chinese banks are cleaning up their act, according to analysts in China, who say that a recent surge in new loans is more a reflection of lenders bringing assets on to their balance sheets than necessarily new debt.
New loans in the first quarter totalled Rmb3.01trn (US$482.3bn), a 9.6% rise over the same period last year and the highest number since the first quarter of 2009, when new loans amounted to Rmb4.58trn, according to data from the People's Bank of China compiled by Thomson Reuters.
Banking analysts, however, are saying that a good chunk of the new lending is actually a result of a reduction of interbank assets in anticipation of tighter regulation. Many of those interbank assets are essentially loans to corporate borrowers via trusts or other arrangements.
"There has been a rumour that the [China Banking Regulatory Commission] will soon release new rules to regulate banks' interbank business. Some banks have been reducing exposure to interbank lending and borrowing - such as Xiamen Bank - in anticipation of the new regulations," said Qiang Liao, a Beijing-based banking analyst for S&P.
A recent report by Deutsche Bank pointed out that banks reduced their interbank assets by 1.5% in 2013 to Rmb1.7trn, or an average of 10.4% of total assets. Analysts suggest that the move continued and possibly even quickened in the first quarter.
Interbank lending had experienced significant growth over the past few years as a way for banks to circumvent the loan-to-deposit ceiling and to set aside less capital for their loan books. In order to record a loan as interbank assets, banks typically route corporate loans through other banks and thus register the debt as credit exposure through the interbank market, which is not constrained by loan-to-deposit ratios.
Xiamen Bank's interbank assets dropped by about 50% in the second half of last year compared to the first half. Other mid-tier banks such as China Minsheng Banking Corp and Industrial Bank - which have much higher exposure to interbank lending than big banks - also scaled back interbank assets in 2013, respectively by 8.9% and 6.9% versus total assets.
One common way to convert interbank lending back into regular loans is to have the counterparty bank return the funds issued by the original lending bank. Then, the lender reclassifies the lending as a direct corporate loan.
The theory finds further support in the fact that the surge in new loans has not been accompanied by a pick-up in growth, as was the case in 2009.
Analysts suggested that the recent slowdown in trust lending may also be part of the same movement. Growth in credit issued by the shadow banking system in 2013 dropped to 32.2%, from 36.8% in 2012 and 49% in 2011, according to the Deutsche Bank.
The deceleration is mainly due to slower growth in trust assets, which account for about 60% of the shadow credit, totalling around Rmb19.6trn as of end-2013.
Data released by China Trust Association last week showed that growth in trust assets slowed to 7.5% in the first quarter of this year compared to the last quarter of 2013. The slowdown began in the second quarter of 2013, with quarterly growth rates at 7%-8.3% compared to an average of 11.8% in previous three years.
Part of the move from trust lending to direct bank lending, however, is also the result of a shift in investor sentiment.
"The slowing Chinese economy translates to lower demand for trust financing and investors also have less appetite for high-risk investments," said Simon Gleave, regional head of financial services at KPMG.
Gleave suggested investors have started demanding more options from their banks instead of third-party wealth managers or trusts. Such a move would make lending directly from the balance sheet easier for banks.
However, even with more investors putting their money in the banks, bringing the loans back to the books could push some institutions to quickly run into the 75% loan-to-deposit ratio cap set by the China Banking Regulatory Commission. If that were to happen, the sudden surge in new loans could quickly turn a significant drop.
Yet, a sharp deceleration may not come any time soon.
"The Chinese economy is still growing and the regulators are careful to make sure the new rules are not so tough as to hurt economic growth," a Hong Kong-based analyst said. (Reporting By Lianting Tu; editing by Christopher Langner, Philip Wright)