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CHINA MONEY-Attack on shadow banking delivers Pyrrhic victory
August 29, 2013 / 5:18 AM / 4 years ago

CHINA MONEY-Attack on shadow banking delivers Pyrrhic victory

* PBOC data shows shadow banking volumes slowing since April

* Restores dominance of bank lending

* Credit diversification invited speculation by SOEs - economist

* Policy curbs speculation but private sector still lacks options

By Pete Sweeney and Lu Jianxin

SHANGHAI, Aug 29 (Reuters) - The loan officers at Chinese banks are back on top of the country’s financial food chain thanks to a crackdown on riskier alternative forms of finance, but the restoration of bank dominance marks a setback in China’s drive to restructure its financial markets.

China’s economic reformers have been trying for years to diversify the country’s credit markets to give companies new ways to raise funds and reduce the dominance of banks, which have tended to favor state-owned companies at the expense of more competitive private firms.

By early 2012, alternative products like corporate bonds and entrusted loans had overtaken bank lending as the leading form of finance in China.

But the revolution was short-lived. Central bank data shows that bank lending staged a dramatic comeback in recent months, with the proportion of bank loans in all new credit rising in July to 86.5 percent of what China calls total social financing, or TSF. That’s more than double what it was as recently as March.

“This marks a failure, albeit perhaps a temporary one, for the official drive to push corporates to rely primarily on the market for fundraising,” said a senior money market dealer at a state-owned bank in Beijing, who asked not to be named because he is not authorised to speak to the media.

Private companies generate most of China’s jobs, but cannot count on credit from China’s largest banks, which tend to funnel most of their credit to state-owned firms with deep political connections - whether they have good use for the money or not.

Economists say the result is a cash-starved private sector that has to pay rates higher than it deserves or can afford on one hand, and state-owned firms on the other with more fixed assets than they need borrowing at rates lower than their business prospects justify.

“The real problem with the bank loan and deposit system is that because the price of the money is fixed by the state, the market is not efficient,” said Yuan Ding, head of the finance and accounting department at the China Europe International Business School (CEIBS) in Shanghai.

“This means the banks cannot deal with clients to whom they cannot charge high interest rates, so those people are left out of the system, which is why we have this alternative system to finance these people.”

Promoting new forms of finance like corporate bonds and trust loans, officials hoped, would help reduce this misallocation of credit and get loans to borrowers at prices that reflect their ability to repay, not the likelihood of them getting help from Beijing.

But an explosive, 59 percent year-on-year increase in new credit in the first three months of 2013, to a quarterly record 6.2 trillion yuan ($1.3 trillion), shocked regulators expecting TSF growth less than a third that pace.

The problem, economists say, is that this surge in new forms of financing such as trust loans, bankers’ acceptance notes and high-yielding corporate bonds, was not accompanied by a corresponding surge in economic growth. Instead, much of the money appears to have been used to fund real estate speculation or in complex rate arbitrage schemes executed by state-owned firms in sectors suffering from overcapacity.

Rather than pricing credit more efficiently, therefore, economists worried that financial innovation was actually aggravating risk by making speculation and bad debt rollovers by local governments more difficult to detect.

“I don’t think the development of the shadow banking sector was actually solving the credit problem,” said Wei Yao, an economist at Societe Generale in Hong Kong. “All it meant was LGFVs [local government financing vehicles] were going into the shadow-banking market and squeezing out the private sector.”

The impact of the crackdown, which combined administrative measures with a credit crunch in late June, has been dramatic.

Companies sold just 46.1 billion yuan in bonds in July, according to the People’s Bank of China, 12 percent what they were able to raise in March. The outstanding value of banker’s acceptance notes -- another popular form of credit -- fell by a net 554.4 billion yuan from the end of April to the end of July.

Growth in trust loans, a type of off-balance sheet lending frequently bundled into China’s high-yielding wealth management products -- decelerated sharply in the second quarter, to 8.3 percent in the second quarter, from 16.9 percent in the first quarter, according to the China Trustee Association, a semi-governmental association.

Yao argued that this marked less a step backward than a failure to move forward. She said that while the private sector had seen little benefit from the financial innovation free-for-all, the crackdown was not coupled with reforms that might steer more credit to private companies - leaving them no better, and perhaps even worse off, than before.

“Sadly to say, not much reform is moving in the direction of helping the private sector get money more directly,” she said.

Economists now hope Beijing moves quickly to liberalise deposit rates, which would allow banks to compete for depositors, and some pointed to the planned introduction of tradeable certificates of deposit as a step in that direction. But others are skeptical that Beijing would risk weakening one of its best tools for directing the economy when the economic and financial outlook is so uncertain.

China may never be able to create a true market for credit that prices risk efficiently until it can dispel the perception among investors and bankers that lending to politically connected borrowers involves no risk at all - what bankers refer to as “moral hazard”. Chinese officials have repeatedly moved to rescue connected firms from default or bankruptcy.

“The problem is the implicit guarantee in any financing vehicle,” said Yuan at CEIBS.

“By talking with Chinese government officials, you can tell they don’t believe in the market economy. They chose the market for opportunistic reasons. They really think they can manage the economy, that is their belief.” ($1= 6.12 Yuan) (Editing by Wayne Arnold and Dean Yates)

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