Concluding this year’s Article IV mission, IMF officials gave a stark warning on credit growth:
“Notwithstanding this relatively favorable near-term outlook, China’s economy faces important challenges. In particular, the rapid growth in total social financing—a broad measure of credit—raises concerns about the quality of investment and its impact on repayment capacity, especially since a fast-growing share of credit is flowing through less-well supervised parts of the financial system.”
The growth of total social financing has indeed been rapid, growing by 59 percent in the first quarter of 2013 compared to 2012, the most rapid growth since the 2009 stimulus-induced lending boom.
The components total social financing show a marked divergence in terms of their growth rates. Traditional renminbi loans have grown sluggishly and equity issuances have actually declined. The fastest growth has been in trust loans, growing a staggering 378 percent compared to the same period last year. Trust loans have grown from 1.6 percent of social financing at the end of 2011 to 13.4 percent by the first quarter of 2013.
If any institutions fit the classic definition of shadow banking in China, it’s trust companies. Trust companies take money from institutional investors and individuals and make loans and investments to a wide variety of projects. Some of these projects go into the riskiest sectors, like real estate and private equity. Trust companies are also an active source of funds for local governments, providing finance for local government investment platforms. Reflecting their growing role in the economy, the assets of trust companies increased 65 percent year-on-year in the first quarter of 2013, reaching 8.7 trillion renminbi.
China’s banks have a history of close cooperation with trust companies, usually too close according to banking regulators. Previously, the largest channel for bank involvement with trust companies was through the Bank-Trust Cooperation Products (银信理财合作产品). These products created a channel for banks to invest directly in trust products and grew rapidly for years. In 2010, banking regulators decided that Bank-Trust Cooperation Products had evolved into a conduit for off-balance sheet loan making for bank and subsequently put significant restrictions on this activity. Additionally, regulators required banks to bring these product back on-balance sheet by then end of 2011, reducing their usefulness as a way to bypass loan quantity restrictions. Despite the crackdown, the outstanding balance of Bank-Trust Cooperation assets still exceed 2 trillion renminbi.
Undeterred, banks have found new avenues to invest in trust companies. Up until the middle of 2012, banks were guiding wealth management product funds into trust investments via single-unit trusts (单一资金信托). Single-unit trusts are offered to a sole institutional investor who has significant control over the structure and target of the investment, as opposed to combined unit trusts (集合资金信托) which are sold in chunks to multiple investors. Single-unit trusts account for 70 percent of all trust investments.
In the second half of 2012, the China Banking Regulatory Commission warned banks against putting wealth management product funds into trust investments. Subsequently these financing structures became a lot more complicated. As Caixin illustrates in a recent investigative piece (CN), banks are now using conduit companies and other banks to invest in trust thus avoiding the normal prudential regulations.
The normal risk weighting for corporate debt is 100 percent, while interbank debt requires only a 25 percent weighting. To take advantage of this difference, a third-party bank will take a trust investment transfer it to another bank via a repurchase agreement. For the receiving bank, the trust investment can be classified as redemptory monetary capital for sale (买入返售金融资产). Because the counter-party is another bank the asset only requires a 25 percent risk weighting. The end result is that banks can make investments in trust companies without being subject to the normal prudential regulations. Trust companies in turn can use the funds raised to extend financing to corporations cut off from bank lending.
With the rapid growth of trust companies and re-purchasable financial assets activity by many banks, it’s only a matter of time before regulators crackdown on this convoluted financial structure. Regardless, the game of whack-a-mole between Chinese banks and banking regulators will persist. As long as the demand for credit from Chinese enterprises remains high, banks will find new channels through the shadow banking sector to extend loans. The IMF is quite correct in highlighting the potential systemic risks from rapid credit growth in such a poorly regulated sector.