China took another step to clamp down on leverage in the financial system, ordering banks to ensure they aren’t exposed to risks from their entrusted loan business.
Banks can only act as intermediaries when arranging entrusted loans, and must not provide guarantees or get involved in decision-making, according to new rules posted in a statement on the China Banking Regulatory Commission’s web site over the weekend.
The CBRC’s measure is the latest attempt by China to curb the threat that excessive leverage in the financial system poses to the nation’s economy. President Xi Jinping and his senior economic officials have vowed to make controlling financial risks a top priority, a pledge renewed at the Communist Party’s twice-a-decade leadership congress last October.
The entrusted loan business, which normally involves companies providing finance to each other with banks acting as intermediaries, has seen “certain potential risk hazards” due to rapid growth and a lack of regulation, according to the CBRC statement. Entrusted loans can’t be used for investments in bonds, derivatives, asset-management products or equities, the CBRC said, adding that banks cannot put their own money or funds they manage into such loans.
Entrusted loans contain higher credit risk because they are less regulated and often extended to risky areas, such as local government financing vehicles and property developers, according to Terry Sun, an analyst at RHB Securities Hong Kong Ltd. Higher yields offered by entrusted loans have prompted some nonfinancial corporates to put their spare cash in such offerings, he said.
“This would magnify system leverage and push up funding costs for the real economy,” Sun wrote in a note. The CBRC’s measure should therefore “reduce leverage and the circulation of capital within the financial system.”