China's banking authority announces tighter rules to combat systemic risk

The China Banking Regulatory Commission has announced rules to further standardize the management of entrusted loans, strictly restricting the sources and uses of such funding.

The tightened regulations seek to defuse commercial banks' off-balance-sheet risk exposures, and to stop funds from being funneled into the housing sector and local government financing vehicles, according to bankers and academics.

Cai Qian, deputy head of corporate banking at the Industrial and Commercial Bank of China Ltd, was quoted by media reports as saying that the new regulations are focused on the prevention of systemic risks and the need to better serve the real economy.

He added the new rules reclarified the roles and boundaries of each entrusted loan participant.

Listed by Moody's Investors Service as core shadow banking activity, entrusted loans are organized between borrowers and lenders by an agent bank. The agent bank charges a handling fee, but does not undertake the loan risk.

The CBRC, China's top banking regulator, issued the new rules forbidding commercial banks from offering entrusted loans with funds from others, bank credit, special funds created for a specific purpose, other forms of debt capital, and funds with unproven sources.

The rules will prevent corporate investors from investing in non-standard credit assets in the form of entrusted loans through wealth management products offered by banks, securities firms and fund management companies, said Wen Bin, chief analyst at China Minsheng Banking Corp Ltd.

Commercial lenders have used such products to evade regulatory control over the scale of bank credit, granting loans to restricted businesses or industries and causing a rise in banks' off-balance-sheet credit risk, Wen said.

China International Capital Corp Ltd, the country's first joint-venture investment bank, said in a report that in September 2017, the value of new entrusted loans and trust loans totaled 320.1 billion yuan ($49 billion), dominated by non-standard financing for the real estate industry.

This situation is set to change, as regulators prohibit commercial banks from using entrusted loans for investment in bonds, futures, financial derivatives and asset management products, for the verification of registered capital, for equity investments, or for capital increases and share expansion.

"The rules introduced by the CBRC will curb the flow of funds into the housing sector, local government financing vehicles and industries tackling excess capacity," Wen said.

In recent years, entrusted loans have grown rapidly in part due to regulatory restrictions on the scale of bank credit. But that growth momentum slowed last year, as China stepped up regulation to prevent systemic financial risks.

The People's Bank of China, the country's central bank, found that at the end of November 2017, outstanding entrusted loans had increased by 8.7 percent from the same period of 2016 to 13.91 trillion yuan, down from the 20.9 percent growth seen the previous year. That accounted for 8 percent of total social financing, a metric used in China to measure liquidity in the economy.

Xiao Yuanqi, director of the CBRC's prudential regulation bureau, said regulators have been able to contain frequent eruptions of financial market chaos by stepping up efforts to investigate and punish such arbitrage activities last year. As of Dec 1, the growth of entrusted loans had fallen by 896.1 billion yuan year-on-year since the beginning of 2017.