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Policy Options for Mitigating "Shadow Banking" Risks in China

Jul 03,2015

By Lei Wei, Research Institute of Finance of DRC

Research Report, No.172, 2013 (Total 4421)

I. Supervision Measures Implemented by the Regulator Before 2013 and Relevant Effects

1. Supervision measures from 2009-2010

In response to the problems and potential risks in banks' wealth management business, China Banking Regulatory Commission (CBRC) has promulgated a series of laws and regulations since 2009, but still failed to control banks' impulsive activity in off-balance sheet regulatory-arbitrage (particularly bank-trust cooperative wealth management business). Table 1 shows the game between financial institutions and the regulator.

Table 1 Game between Banks and the Regulator in Wealth Management Business

Supervision policies pertaining to banks’ wealth management business

Game between financial institutions and the regulator

Policy

Time

Main content

Notice on the Issues Relating to Further Regulating Investment Management of Personal Wealth Management Business of Commercial Banks (No. 65 issued by CBRC in 2009) 

July 2009

1. Banks are required to distinguish between customers with investment experience and those without investment experience, and the wealth management products only suitable to customers with investment experience shall not be marketed to those without investment experience.

2. Wealth management funds shall not be invested in the stocks publicly traded in domestic secondary market, or relevant securities investment funds, or equities of unlisted enterprises, or the  non-publicly issued or traded shares of listed companies (except for private banks). 

1. Many banks have lowered their standards of high-end customers as supervision policies do not clearly regulate or define “investment experience” and “high-net-worth customers”;

 2. The regulator does not restrict banks' investment in credit assets with wealth management funds, providing conditions for banks to develop wealth management products linked to credit assets on a large scale. 

Notice on the Issues Relating to Further Regulating Bank-Trust Cooperation (No. 111 issued by CBRC in 2009)

December 2009

Wealth management funds shall not be invested in the credit assets or commercial paper assets of the banks which issue such wealth management products. 

Commercial banks transfer their existing credit assets to trust companies to transform them into trust property, and concurrently issue wealth management products to purchase the beneficial right of trust under the trust property. 

Notice on the Issues Relating to Regulating Credit Asset Assignment and Wealth Management of Credit Assets (No. 113 issued by CBRC in 2009)  

December 2009

Credit Asset transfer must strictly follow the principle of truthfulness; the assignor and the transferor must properly deal with the transferring process to ensure relevant risks are borne at any time. 

Banks cross hold the wealth management products with credit assets of each other as the subject matter, i.e. the alleged “cross-holdings”. 

Notice on the Issues Relating to Regulating Bank-Trust Cooperation on Wealth Management Business (No. 72 issued by CBRC in 2010)

August 2010

1. Trust companies’ financing business based on the bank-trust wealth management cooperation is subject to balance proportion management, whereby the proportion of financing balance in the balance of bank-trust wealth management cooperation business shall not exceed 30%; 

2. The maturity of trust products shall not be less than one year. 

1. Banks lower cooperation threshold, pay attention to the financing balance indicator of trust companies but reduce the requirements on their management capability;

 2. Banks create the abstract concepts such as “trust interest settlement period” and “transfer of beneficial right of investment” to get around the regulations on product maturity.

Source: Compilation based on relevant information of CBRC website.

2. Supervision measures from 2011-2012

In 2011, CBRC successively promulgated supervision policies on bank-trust cooperation, mainly including: three principles on credit assets transfer, i.e. truthfulness, completeness and clean transfer;adjustment of the supervision indicators for both the transferor and the transferee; wealth management funds should not be directly used to purchase credit assets; commercial banks should transfer off-balance sheet bank-trust wealth management cooperation business into balance sheet before the end of 2011, set aside loan loss provisions at a rate of 150% and include such assets in risk weighted assets; balance of bank-trust cooperation loans should be reduced proportionally by 25% quarter by quarter; trust companies should set aside risk capital at a rate of 10.5% for the bank-trust cooperation trust loans not included in the balance sheets of commercial banks. Furthermore, the regulator also promulgated supervision policies (Table 2) pertaining to the explicit or implicit repurchase clause, truthfulness of trade background of bill business and interbank payment with respect to the wealth management business of banks.

Table 2 Supervision Policies Promulgated from the End of 2010 to the End of 2012 by the Regulator on Wealth Management Business of Banks

Time 

Relevant policies or measures 

Main content 

December 2010

Notice on Further Regulating the transfer of Credit Assets of Banking Financial Institutions 

The transferor should not arrange any explicit or implicit repurchase clause; both the transferor and the transferee should not hedge supervision by signing of repurchase agreement or spot buyout or forward repurchase; banking financial institutions should not directly purchase credit assets with wealth management funds. 

January 2011

Notice on Further Regulating Bank-Trust Wealth Management Cooperation Business 

Banks should include off-balance sheet assets of bank-trust wealth management cooperation business in their balance sheets before the end of 2011 as required; in principle, the balance of bank-trust cooperation loans should be depressed at a rate of 25% every quarter; trust companies should set aside risk capital at a rate of 10.5% for the bank-trust cooperation trust loans not included in the balance sheets of commercial banks. 

May 2011

Notice on Regulating the Scope and Way of Including Bank-Trust Wealth Management Cooperation Business in Balance Sheets 

Bank-trust wealth management cooperation business due in or after 2012 should be included in risk assets at a rate of 25% every quarter and provisions for such business should be made. With respect to the way of inclusion, the notice requires that the off-balance sheet assets of bank-trust wealth management cooperation business that meet the inclusion standards of the Accounting Standards for Business Enterprises must be included in the balance sheet of each bank; for those not meeting the standards, banks may separately recorded for related products, set aside corresponding provisions, include these assets in risk assets and adjust accounting. 

June 2011

Notice on Strengthening Bill Business Supervision 

Immediately stop the bill business of institutions that have violated regulations, and improve accounting; inspect the truthfulness of trade background of bank acceptance drafts, compliance of movement of discount funds and whether banks hedge regulations on credit scale by bill discounting. 

June 2011

Symposium on Supervision of Wealth Management Business of Commercial Banks 

Explicitly require that bills and other financing assets, trust loans and beneficial right of trust should not be included in the asset pool of wealth management products. 

August 2011

Notice on Further Regulating Bank-Trust Wealth Management Cooperation Business (No. 7 Document) 

Balance of bank-trust cooperation loans should be depressed at a rate of 25% every quarter; trust companies should set aside risk capital at a rate of 10.5% for bank-trust cooperation trust loans not included in balance sheets of banks. 

November 2011

The 4th Meeting of CBRC on Analysis of Economic and Financial Performance 

Banks are prohibited from luring savings deposits by offering high interest rates, hedging regulatory requirements or engaging in supervision arbitrage by issuing short-term wealth management products. 

January 2012

Window Guidance 

Halt the issue of bill trust products of trust companies  

March 2012

Notice on the Issues Relating to Bill Trust Business of Trust Companies 

Formally prohibit the bill trust business and bank-trust cooperation business of trust companies that are interpreted by the market as bill collective trust business 

March 2012

Draft for comment on Notice on Regulating the Management of Interbank Payment Business 

Banks' interbank payment business must follow the principles of holding true trade background, making true accounting treatment and representing trust entrusted payment. 

July 2012

Draft for comment on Some Provisions on Bill Business Management 

Banks are required to strengthen internal management of bill business and centralize the independent approval rights of operating outlets; the People's Bank of China also particularly mentioned the internal management of bill business, in addition to standardization of bill business in respects of commercial draft users, bill endorsement, modification and payment prompt; after discounting of paper commercial drafts, the banks holding the commercial drafts should only transfer the drafts to other banks, finance companies or the People’s Bank of China. 

August 2012

Notice on Regulating the Management of Interbank Payment Business 

Business due before the end of 2012 may be settled naturally upon maturity; business due after the end of 2012 should be rectified by December 31, 2012 as required.

3. Comments on supervision effect

Some data show that the policies of the regulator seem to yield results, for example, among bank-trust cooperation business, the wealth management products directly linked to credit assets have significantly shrunk since 2011 ( Figure 1). But there are signs that banks and non-banking financial institutions still continue the game with the regulator adopting more complicated transaction modes.

First, regarding from assets linked to bank-trust cooperation products, the proportion of credit assets such as credit assets, trust loans and bank acceptance drafts decreased sharply, while credit proportion of portfolio assets increased remarkably. Portfolio assets may include such standardized and highly liquid assets as interest rate assets, exchange rate assets and bonds, or unstandardized creditor's assets such as credit assets, bills and beneficial right of trust.

The article was published in China Development Review, No 1, 2014.

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