China is targeting high level officials and wealth management products in its assault on shadow banking. But measures only tackle the supply, not the reasons behind the demand for unregulated financing.
The crackdown on shadow banking and financial sector malpractice that Chinese regulators intensified in early 2017 is not new. China has unleashed tough directives before, clamping down on trust loans a couple of years ago and banning local government financing vehicles (LGFVs) from printing bonds in 2016.
The targeting of high-profile figures in the China Banking Regulatory Commission (CBRC) and the China Insurance Regulatory Commission by China’s corruption watchdog makes the 2017 initiative particularly tough. But these efforts alone might not be enough to resolve the key problem, which is de-leveraging an economy whose total debt is two-and-a-half times its gross domestic product.
The People’s Bank of China (PBOC), the central bank, is tightening up on wealth management products, which fund almost half of Chinese shadow assets. But the PBOC has asked banks to only include non-cash wealth management instruments in their quarterly macroprudential assessments.
Meanwhile, the CBRC has issued a flurry of directives condemning malpractice. But the deadline by which banks had to complete self-assessments based on these guidelines has already slipped, and the CBRC has not announced a new one. Additionally, the assessment results will not be made public, and even less is known about China’s smallest lenders, which tend to be heavily involved in shadow banking.
For China’s clampdown to succeed, it will need to be sustained. But in the past, as soon as tighter directives dented economic growth, regulators have relaxed their grip. This year, the central bank has already injected liquidity in the market after interbank rates began creeping up.
The problem of Chinese overleveraging goes beyond financial regulation. Crackdowns are necessary, but they cannot only focus on shadow finance supply. The root problem is upstream, in the demand for shadow finance from entities that do not have access to formal funding, such as companies suffering from overcapacity or LGFVs.
This demand is symptomatic of an even bigger issue. As long as China continues filling the gap between its headline growth rate and its actual growth potential with fiscal and monetary stimulus supported by financial credit, debt – as well as financial risk – will continue to grow.
