China’s Cabinet Drafts Shadow-Banking Plan

China’s Cabinet Drafts Shadow-Banking Plan

LINGLING WEI And BOB DAVIS

an. 6, 2014 3:02 a.m. ET

BEIJING — China’s cabinet has drafted a new framework for beefing up regulation of shadow-banking activities, in a sign that the Chinese leadership is seeking to slow the growth of debt and bolster the country’s economic stability.The plan was distributed to regulators by the State Council at the end of last year, according to officials who have seen the document, but it hasn’t yet been made public. The document sets out to limit the growth in loans created outside formal channels for bank lending and calls for stronger oversight of informal lending by the country’s regulators including the central bank.

Under the rules laid out in State Council document No. 107, regulation of different kinds of shadow-banking activities will be carried out “one by one,” according to the people who have viewed the documents.

Still, the plan says that shadow lenders — a mélange of trust companies, insurance firms, leasing companies, pawnbrokers and other informal lenders — have played an important role in the economy, suggesting the leadership has little intention to launch a crackdown on the sector as some economists have urged. Shadow banking is an “inevitable” result of financial innovation and has played an “active” role in serving the economy and broadening the investment channels for Chinese individuals, according to the people who have seen the framework.

The State Council document comes on the heels of similar statements by various government agencies on economic priorities, including restructuring the state-owned sector, opening China’s government contracting sector to foreign firms, clearing the way for more rural migrants to settle in China’s cities, and defining what’s permitted in a new free-trade zone in Shanghai. In all the cases, Chinese officials stated general principles, but left the details to be issued later by regulators.

Essentially, the Chinese government is trying to put into action the general pronouncements made during a November meeting of top Communist Party leaders, which pledged that market forces would play a “decisive” role in the economy.

Shadow banking presents an especially difficult challenge. On the one hand, Beijing wants to encourage the development of nonbank financial institutions, which often lend at market rates to smaller firms that are overlooked by China’s biggest state-owned banks. Additionally many important borrowers, especially local governments, are heavily indebted and owe much of their financing to nonbank sources.

Overall, 43% of local government’s 17.9 trillion yuan in debt ($2.95 trillion) as of the end of June 2013, came from nonbank sources, according to a National Audit Office report released last week. Shadow banking institutions, including trust companies, securities firms, insurance companies and leasing companies accounted for 11% of the local government debt. The rest of the nonbank debt is from bonds, individuals and a variety of loan guarantees. Any crackdown on shadow banking could threaten the financial viability of the governments and their ability to repay loans and bonds.

On the other hand, the rise of shadow banking has been a major reason that China’s debt has grown at a pace similar to the U.S., Europe and Asian nations before they crashed. Since 2008, domestic debt has ballooned to 216% of GDP from 128% and could climb to 271% by 2017 if not corrected, according to Fitch Ratings. The central bank and regulators have been debating how to reduce the pace of growth without tanking the economy.

Chinese Premier Li Keqiang said late last month that while China would keep a prudent monetary policy as well as “appropriate” liquidity next year, he expected there would be reasonable growth in credit. He gave no hint of a crackdown.