May 3, 2016 / 6:40 AM / 3 years ago

China's banking regulator moves to contain off-balance sheet risk

BEIJING, May 3 (Reuters) - China’s banking regulator, in a move to rein-in a rapidly growing ‘shadow loans’ industry, has instructed commercial lenders to properly account for lending products that may appear on their balance sheets as lower-risk investments.

Authorities are tightening scrutiny of the lenders, as the growth of complex financial structures by commercial lenders may be used to conceal bad lending and credit risks.

The new rules forbid commercial banks from entering into repurchase agreements once a loan’s income rights have been transferred, according to a document issued by the China Banking Regulatory Commission (CBRC), a copy of which was seen by Reuters.

Banks also are now required to make adequate provisions for transferred loans where the underlying loan assets remain on their balance sheets.

Individual investors also are forbidden from investing in bad loans through bank-issued wealth management products.

Banks and financial institutions have used the transfer of income rights from credit assets to improve their business, the CBRC said in the document, but “part of the credit-related transactions are non-standard and opaque” and are not properly accounted for by the banks.

Analysts say the new rules, issued last week, are meant to provide greater transparency and address the rampant growth of investment receivables that are now accumulating on bank balance sheets, particularly among mid-tier lenders.

The size of China’s ‘shadow loan’ book rose by a third to $1.8 trillion in the first half of 2015, equivalent to 16.5 percent of all commercial loans in China, according to an analysis by UBS Investment Bank.

The growing use of financial structuring, which involves structures known as Directional Asset Management Plans (DAMPs) or Trust Beneficiary Rights (TBRs), comes at a time when some mid-tier lenders, under pressure from China’s slowest economic growth in 25 years, are already delaying the recognition of bad loans.

Banks are required to set aside capital against their credit assets - the riskier the asset, the more capital must be set aside, earning them nothing.

Loans typically carry a 100 percent risk weighting, but these investment products often carry a quarter of that, so banks can keep less money in reserve and lend more.

Banks must also make provision of at least 2.5 percent for their loan books as a prudent estimate of potential defaults, while provisions for these products ranged between just 0.02 and 0.35 percent of the capital value at the main Chinese banks at the end of June, Moody’s Investors Service said in a note in December.

In March, the banking regulator issued a document prohibiting the country’s asset management companies (AMCs) from signing private agreements with banks, including implicit repurchase guarantees, which would serve to mask real non-performing loan levels by allowing the banks to temporarily warehouse sour loans with the AMCs. (Reporting By Matthew Miller and Meng Meng; Editing by Simon Cameron-Moore)

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