Why Chinese shadow banking activity stopped growing in 1H17

Nominal GDP also grew faster than shadow banking assets.

Moody's Investors Service says that broad shadow banking activity in China stopped growing during the six months between January and June 2017 (H1 2017). And, for the first time since 2012, nominal GDP grew faster than shadow banking assets during H1 2017, resulting in such assets falling to 82.6% of GDP at 30 June 2017 versus a peak of 86.5% in 2016.

"Chinese shadow banking activity stopped growing in H1 2017 because of a fall in first, the issuance of higher risk instruments such as the banks' wealth management products, and second, non-bank financial institutions' asset management plans," says Michael Taylor, a Moody's Managing Director and Chief Credit Officer for Asia Pacific.

Here's more from Moody's:

Moody's points out that the share of wealth management products held by interbank investors has begun to fall, while the banks' claims on non-bank financial institutions are also declining; indicating that recent regulatory measures are having some effect in reducing financial system interconnectedness and addressing financial system vulnerabilities created by increasingly complex and opaque funding chains.

"However, core shadow banking activity — including entrusted loans, trust loans, and undiscounted bankers' acceptances — has continued to grow, increasing in share when compared with the broad shadow banking sector," adds Taylor.

"Following the 19th Chinese Communist Party Congress, financial-sector regulation will likely continue to restrain the growth of shadow banking activities and address some key imbalances in the financial system," says George Xu, a Moody's Analyst. "However, the challenges associated with regulatory tightening and the broad deleveraging campaign remain."

Moody's conclusions are contained in its latest "Quarterly China Shadow Banking Monitor," and is co-authored by Taylor and Xu. The publication draws on publicly available data sources to provide an overview of trends and developments in this important component of the Chinese financial system.

Moody's report explains that credit demand from the real economy remains strong and is being met by the continued expansion of core shadow banking activity, through bank lending and corporate bond issuance.

Specifically, core shadow banking is continuing to show signs of strong growth, with trust and entrusted loans growing and undiscounted bankers' acceptances expanding for the first time in three years during Q3 2017. Bank lending remains strong, with growth to the household sector in particular picking up. Corporate bond issuance also ticked up in Q3 2017. Aggregate leverage is still rising, although overall credit growth inched down during the three months to 30 September 2017, while nominal GDP growth stayed stable.

Moody's explains that the People's Bank of China has increased liquidity supply — through long-term repo operations — to allow the banks more time to wind down their investment portfolios. Mid-size and smaller banks in particular are reducing their reliance on wholesale funding and depending increasingly on central bank funding.

However, the new issuance of interbank negotiable certificates of deposit reached a record high in September 2017, suggesting that some mid- and small-sized banks face rollover pressures.

On the issue of regulation, Moody's says that the authorities face an ongoing challenge in preventing the de-risking of the financial sector from causing systemic disruption. The limited transparency of some shadow banking products and the tendency for regulatory measures to lead to financial innovations designed to evade them add to the challenge.

Moreover, the ability of the formal system to replace shadow credit faces limits, and bank credit may not prove a perfect substitute for shadow credit.