China’s war on ‘channel lending’

Author: Brian Yap | Published: 17 May 2016
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China’s banking regulator has waged war on shadow banking, as a six-fold spike in debt receivables last year has rattled the debt-ridden banking sector.

The China Banking Regulatory Commission (CBRC) issued a notice last month requiring all banks seeking to transfer loan proceeds to lodge a filing explaining the purpose behind the disposal of any loan proceeds and non-performing loans (NPL).

But local counsel are worried that small banks, with their limited capital, will find it challenging to comply with the new regime, whose ban on so-called channel lending could push debt-ridden state-owned enterprises (SOE) into bankruptcy.

Yang Tiecheng, Clifford Chance
Yang Tiecheng,
Clifford Chance
“Smaller banks, they have more pressure than big banks and because they are quite small and their capital is small as well, they have pressure to get capital relief for them to get new loans,” said TieCheng Yang, partner at Clifford Chance in Beijing. “In terms of compliance, it is more of a challenge to smaller banks.”

With the economic slowdown, second tier banks in particular that have failed to extend new loans under tougher capital requirements have sought capital relief by acquiring loan proceeds.

Many have issued wealth management products in exchange for loans or loans’ proceeds, which will not be treated as liabilities on their balance sheets.

This has led to an upshot in debt receivables, trust beneficiary rights or private placement asset management plans bought by banks from intermediaries, such as trust companies and brokerages. 

Last year, these investment receivables soared 63% to RMB14tn ($2.2 trillion) amounting to 16.5% of the formal loan book, according to analysis of 103 Chinese banks by Wigram Capital Advisors.

Under the new regulations, banks seeking to acquire loan proceeds by issuing wealth management products must register with the banking registration centre, which was established in 2014. The CBRC has also required the transferring banks to make full provisions for any transferred loan rights.

KEY TAKEAWAYS

  • China’s banking regulator has waged war on shadow banking among PRC financial institutions, as a six-fold spike in debt receivables recorded last year has further rattled the debt-ridden banking sector.
  • CBRS last month issued a notice requiring all banks seeking to transfer loan proceeds to do a filing with the regulator explaining the internal use behind the disposal of any loan proceeds and non-performing loans.
  • But local counsel are worried that small banks will find it challenging to comply with the new regime, whose ban on channel lending could see debt-ridden SOEs go bankrupt.

Counsel tell IFLR that such mandatory full provisioning is aimed at stripping them of their ability to achieve off-balance-sheet treatment, rendering them unable to extend new loans.

They argue that, by issuing these products backed by loans to indebted companies, banks are simply moving their NPLs around while taking advantage of the off-balance-sheet status given to products issued by financial institutions.

“Banks use wealth management products to buy the loans that the banks extended…basically trading between the left pocket to the right pocket,” said Yang.

Another strict impact is a direct prohibition on a bank to use its own wealth management products to buy loan proceeds by itself. Counsel point out that, if a bank transfers or sells their loan proceeds but provides any repurchase arrangements concurrently obligating itself to buy the proceeds back, then it is not a real transfer.

“That’s just a repo and therefore is prohibited under the new CBRC notice,” said Yang.


In terms of compliance, it is more of a challenge to smaller banks


Channel lending

Financial institutions in China have long engaged in channel lending, in which banks extend loans to a corporate borrower via an intermediary, from whom they purchase beneficiary rights.

As the law requires that all banks make a 25% provision for debt receivables, compared to 100% for loans, such a practice has enabled banks to circumvent the rules while getting sufficient capital relief. 

But with the recent ban on channel lending, counsel fear that these struggling SOEs, especially those in over-capacity sectors, could go bankrupt as they are already facing restrictions on formal borrowing.

“The inability to conduct channel lending will put more pressure on the troubled SOEs in finding their funding resources to maintain their existing business operations,” Jian Fang, partner at Linklaters in Shanghai. “This may force some smaller market players in those industries to go bankrupt but there will not be a wave of bankruptcies as the government will do its best to avoid any large-scale redundancies,” he added.

Counsel tell IFLR that, while the new rules will help improve lending standards, it is difficult to judge whether this move will be sufficient. They argue it will be a huge blow to big banks’ capital and hence their profitability in the short term, while stressing the positive effects on banks in the long run.

“Over time this will be positive as the banks will now have good reasons to turn to the NPL asset managers to offload their loans to large SOEs in overcapacity industries,” said Fang.

See also

China’s NPL plans risks shifting burden

China NPL scheme hampered by disclosure gaps

Asia Pacific: Fighting the zombies