Caixin Explains: What the Central Gov’t Thinks of Shadow Banking

01.10.2014 19:39

Caixin Explains: What the Central Gov’t Thinks of Shadow Banking

The cabinet gave regulators and others its thoughts on the opaque sector, then essentially left the matter in their hands

By staff reporters Zhang Yuzhe, Huo Kan and Wu Hongyuran

(Beijing) – A notice on shadow banking released by the State Council, the country’s cabinet has been circulating online since October and was recently confirmed by sources from major banks to be authentic.The regulation, known as document No. 107, was handed out in December to the central bank, the regulators of the banking, securities and insurance industries, other related central government departments and provincial governments, a source from a large bank said.

This marks the first unified regulatory approach to shadow banking, though it is still far from clear how it will affect the design and implementation of specific rules regarding the opaque sector.

What does the document say shadow banking is?

The document did not define shadow banking. It did not lay out specific standards and criteria for determining whether certain activity is shadow banking. However, it does say that shadow banking takes place through three types of institutions.

The first are credit intermediaries without financial licenses that are unsupervised, including some third-party wealth management companies and an emerging army of Internet companies providing financial services.

Second are credit intermediaries that do not have financial licenses and are supervised, albeit inadequately, including leveraged loan guarantee firms and small-loan companies.

The third were institutions with financial licenses that are not properly supervised, including money market funds, asset securitization schemes and some wealth management products.

Why now and what is the significance of it?

Problems regarding shadow banking have long concerned the central bank and the China Banking Regulatory Commission (CBRC), but it was not until a meeting in July that the State Council made a priority of addressing the problem. A lot more attention was paid to the CBRC’s research on the matter, which constituted the basis of the document that was circulating.

The document has been the country’s most authoritative regulation of shadow banking. It marks a turning point, before which efforts to regulate the sector were fragmented and inconsistent.

The CBRC had argued that trust companies and some off-balance-sheet operations of commercial banks were not shadow banking, considering that they were not highly leveraged. Also, the Ministry of Commerce had long opposed treating pawn shops and financial leasing companies as shadow bankers.

What is the impact on the shadow banking sector and the financial market?

The document lacks operational details for identifying and cleaning up shadow banking operations, requiring only financial regulators to come up with their own enforceable plans.

In essence, it merely consolidated the position the government has always taken, which is to hold financial regulators responsible for problems found in their realms. It is unlikely to have any significant impact immediately on shadow banking and the way financial institutions go about their business.

The CBRC, for example, has repeatedly required banks to separately account for the whereabouts and return of money collected by each wealth management product last year. This was an effort to crack down on the murky practice of “capital pooling.” The effectiveness of the campaign remains dubious. Many insiders say it is impossible to sort out the trillions of yuan worth of investments made before the requirement was announced.

How big is shadow banking in China?

The answer depends on how you define the phenomenon because there is yet no commonly accepted figure. A report by the investment bank UBS estimates the value of the country’s shadow banking at between 13.7 trillion and 24.4 trillion yuan as of September 2012. The lower figure is mainly based on estimates of bank off balance-sheet operations. Others have defined shadow banking as covering many types of non-bank funding mechanisms, such as trust funds and private lending.

What do the experts say?

Analysts and financial professionals worried about shadow banking have argued that the solution to the problem should be a unification of standards and regulations such as entry thresholds and capital requirements of different financial sectors. They say this would reduce the room for regulatory arbitrage. The document emphasized this point without elaborating.