May 3, 2016 / 9:56 AM / 3 years ago

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

BEIJING (Reuters) - China’s banking regulator, in a move to rein-in the rapidly growing ‘shadow loans’ industry, has told 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 growing use of complex financial structures has raised concerns that bad lending and credit risks can be concealed.

The new rules forbid commercial banks from entering into repurchase agreements once a loan’s income rights have been transferred, according to a document from the China Banking Regulatory Commission, 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.

Financial institutions have used the transfer of income rights from credit assets to improve their business, the CBRC said, but added that part of the process was “non-standard and opaque”.

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.

“Some joint-stock commercial banks that have a higher reliance on interbank funds and increasing investments in loans and receivables could see their liquidity deteriorate,” said Minyan Liu, an Associate Managing Director at Moody’s.

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 UBS.

The growing use of financial structuring, which involves structures known as Directional Asset Management Plans (DAMPs) or Trust Beneficiary Rights (TBRs), comes as 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 some investment products 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. 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 December.

Reporting By Matthew Miller and Meng Meng; Editing by Simon Cameron-Moore and Kim Coghill

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