Shadow banking growth will be constrained in 2018 by intensified regulation, says Moody's

Tightened financial oversight in China is demonstrating a growing impact across the shadow banking sector, which will further reduce the sector’s contribution to total social financing flows in 2018, according to the latest quarterly report from Moody's Investors Service.

The rating agency calculates that during 2017, Chinese shadow banking assets increased by one tenth of the amount of the previous year, expanding 1.1 trillion yuan (US$174.3 billion) versus 11.2 trillion yuan in 2016.

The country’s shadow banking activity also declined as a percentage of GDP for the first time since 2012, falling to 79.3 percent at the end of 2017, compared to the peak of 86.7 percent at the end of 2016, according to George Xu, a Moody's analyst and the report's main author.

Xu added that the drivers of the slowdown were declines in some previously fast-growing shadow banking segments such as the banks' wealth management products and non-bank financial institutions’ asset management plans. These two activities have been "the focus" of the authorities' coordinated regulatory actions since the second half of 2016.

Moody's explains that enhanced regulation initially focused on the increasing interconnectedness between banks and shadow banks, targeting in particular the buildup of leverage in the financial sector.

But now the regulatory crackdown has spread to other major core shadow banking components, according to Michael Taylor, managing director and chief credit officer for Asia Pacific at Moody’s.

Due to tightened oversight, the aggregate growth of entrusted loans, trust loans and undiscounted bankers' acceptances has slowed. And the situation will further constrain broad shadow banking growth in 2018 and reduce its contribution to total social financing flows.

The effect of intensified regulation is no longer limited to "de-risking" the financial sector, but is now beginning to impact the supply of credit to the real economy, adds Taylor.

"These measures will likely reduce the supply of credit to more marginal borrowers, who are most dependent on shadow finance," adds Xu. Consequently, refinancing risks will be increasing for some sectors like property developers, local government financial vehicles and companies from overcapacity and polluting industries, he said.

Moody's says that liquidity conditions will continue to tighten for Chinese financial institutions and are particularly great for smaller banks and non-bank financial institutions.

To offset the impact of tighter liquidity, the People's Bank of China has continued to expand direct lending to the banks, with an increasing use of medium-term liquidity facilities.