30th May 2017
Pretty much since the start of 2017, something has been stirring in China’s financial markets. The effects are now becoming more evident. In a nutshell, China has moved – contrary to all the expectations people had that nothing extraordinary would be allowed to happen in this, the year of the important 19th Communist Party Congress – to crack down on regulatory abuse, speculation, leverage and other forms of financial excess. The results may not be fully transparent for a while, and the outcome, if past performance is anything to go by, is liable to be cold feet if and when a the squeeze starts to exacerbate and an already slowing economy.
Nevertheless, whatever it is the authorities are up to is serious, it’s already changing behaviour and it is slowing down the momentum of lending in shadow banking. If the government should ever choose the timing of the eventual denouement of debt, then one day – though probably not this year – this kind of regulatory toughness will link up with macroeconomic tightening to put Chinas credit genie back in its bottle. A proper deleveraging will begin.
Curiously, but not uniquely, what China is doing is both more and less than it seems. It is more than a regulatory crackdown, because it chimes very well with President Xi Jinping’s anti-corruption campaign, which hasn’t really reached into the bowels of the finance sector before, though it has been in a lot of other places in the Party, PLA and SOE sector. The progeny and relatives of a lot of senior leaders, including on the Politburo Standing Committee, work in finance and will doubtless be affected by the shockwaves of arrests, investigations and new restraints in the banking, securities and insurance sectors. How fortuitous for Xi, then, that months before he delivers his political report at the 19th Party Congress, some of his opponents or adversaries are going to feel the chill of his political reach, if not the knock on the door from the Central Commission for Discipline Inspection that runs the anti-corruption campaign.
It is less than it seems because this is not a campaign motivated by the concern that credit creation is an existential economic problem and that the growth of debt must be halted. It is more about curbing regulatory abuses and financial excess, and restoring order indiscipline to a sector that’s been allowed to get away with too much for too long. Further, it is barely conceivable that the authorities will persist for long with strict enforcement of new regulations if the economy should weaken, as it now seems to be following the bounce of the last 6-9 months.
That said, the authorities are making a bona fide effort at a regulatory crackdown, aided and abetted without doubt by the full support of Xi Jinping, whose personal involvement has been significant. He has stated this support for the regulatory crackdown conducted by the People’s Bank of China, and the Banking, Securities and Insurance Regulatory Commissions and spoken about financial security in the same way that he addresses national security.
The first signs of change, that not many really took on board, was this time last year, after the stock market instability had died down, and a new reform-minded head Liu Shiyu was appointed as head of the China Securities Regulatory Commission. There had been widespread stories that senior members of the Commission had profited from leaked information and regulatory conduct associated with the stock market crash in 2015 and the circuit-breaker instability of January 2016. Then, this February, the appointment of Guo Shuqing as head of the China Banking Regulatory Commission in February 2017 was welcomed by many who had been worried by excesses in China’s financial system.
Guo, who had been one of Zhu Rongi’s young proteges, was an outspoken proponent of financial reform and had served as deputy governor of the People’s Bank of China from 2001-2003, Chairman of China Construction Bank form 2005-2011, and head of the China Securities Regulatory Commission from 2011-2013. He is certainly ‘a name in the frame’ for the next head of the People’s Bank when the incumbent Zhou Xiaochuan finally steps down. Soon after being confirmed, he vowed ‘to clean up the chaos’ in the banking system and began to issue a number of edicts aimed at speculators, excessive risk taking, and lax or corrupt management.
Soon after Guo’s appointment, the head of the China Insurance Regulatory Commission, Xiang Junbo, was named by the Central Commission for Discipline Inspection as being under investigation for serious violations of party discipline, and fired. It is no accident that just as Guo launched a series of tougher regulations aimed at banks, the head of the China Insurance Regulatory Commission was dismissed after coming under investigation for party discipline violations. No replacement has been announced as yet but it has announced it too would restore discipline within the insurance sector, including over the generously named ‘universal life insurance policies’, which were more high risk investment products than what they claimed to be.
Official concern about shadow banking activities prompted the People’s Bank of China and the three other principal Regulatory Commissions for Banking, Insurance and Securities to issue a spate of new rules and draft guidelines last month, designed to show they were acting in unison, clamp down on the use of leverage, restrain universal policies and peer-to-peer lending, and allow liquidity to become more expensive so as to discourage short-term fund-raising.
The authorities also want to strengthen risk control in banks and dampen down the growth in wealth management products, especially those linked to property, and curb the activities of banks in this sphere. The guidelines include restrictions on banks paying out on loss-making WMPs, on holding them off-balance sheet to evade capital adequacy requirements, and on including high yield and non-standard debt assets in their WMPs. Earlier this month, the Banking Regulatory Commission issued ‘emergency risk assessments’ of some lender business practices, as well as of lending and investment rules followed by banks that invest in equity markets via WMPs, and make loans to their own shareholders.
Interbank and other market interest rates have risen to the highest levels for two years. They remain quite low, judged by past episodes when the authorities were really trying to shut down liquidity growth, but the rise hasn’t gone unnoticed by small to medium-sized banks and other financial institutions that rely heavily on very short maturity financing to fund loans. Many, according to the IMF, rely on short maturity wholesale funding for about a third of their deposits.
All in all, the regulatory clampdown is both a serious attempt to curb excessive financial and speculative behaviour, and a means to restrain liquidity. Since the start of the year, the regularly published credit aggregate, Total Social Financing, has continued to grow at about 12-13 per cent, but separately published data showing lending to both non-banking financial firms and the government reveal that growth has slowed down from over 20 per cent over in the year to last December to about 15 per cent in the year to April. The overall credit impulse, which analysts monitor, or the change in credit creation, has slowed down a lot as a result of new regulatory changes.
It isn’t totally clear why all this is going on in a year in which most China watchers thought that the 19th Party Congress required the pursuit of stability at all costs and the avoidance of risk-taking at all policy levels. It is quite possible that after all the financial turbulence of the last 2 years, and the periodic recklessness on the part of many bank and non-bank financial institutions in chasing deposits, filed and customers, the prospect of doing nothing looked like a bad financial stability option compared with the risk of trying to restore order and discipline. If so, expect the squeeze to persist for a while, but not if it begins to exacerbate slower economic growth.
China’s 6.5 per cent growth target is sacrosanct for the time being. Since we know this is unattainable without ever more credit creation, it seems like a safe bet that the authorities will back off again before too long.
One day, though, as I discussed in my weeds of finance blog here – and that’s likely to be some time in the next 2 years – they will have to bite the bullet, and engage with regulatory and macroeconomic tightening, and take the consequences. If they don’t, the consequences will consume their best efforts at a managed deleveraging.