China to crack down on 'gray rhino' risks

Tightened supervision to reduce leverage and serve real economy

China's financial watchdogs in the banking and insurance sectors met over the weekend, committing to spend the rest of the year cracking down on risky financial practices that have been neglected, dubbed "gray rhinos," experts said.

Although the overhaul may prompt short-term chain reactions such as a market capital crunch, experts noted that such fluctuations, in the long-run, would help the financial sector to deleverage and make it better serve the real economy.

At the two-day midyear work meeting of the China Banking Regulatory Commission (CBRC) which kicked off on Friday, the regulator pledged to roll out 18 new or amended regulation frameworks this year to deal with potential risks brought by cross-market and cross-sector products and other emerging businesses, according to a statement on CBRC's website.

Additional measures will also be taken to contain risks such as keeping close supervision on highly risky institutions and strengthening internal management and risk control, said the statement.

In another two-day forum organized by the China Insurance Regulatory Commission over the weekend, Chen Wenhui, vice president of the commission, also said that the insurance regulator would beef up efforts in fending off financial risks, and not allow "insurance institutions to serve as financing channels for a small number of people," according to a statement on CIRC's website.

Commenting on the meetings, Dong Dengxin, director of the Finance and Securities Institute at Wuhan University of Science and Technology, predicted that "one of the areas that fall under government's tightened supervision this year would be the flow of domestic banks' new loans."

The country's debt-ridden State-owned enterprises (SOEs), some of whose profit-making ability has been eroded in recent years by stockpiles of inventory and excessive capacity resulting in credit defaults, have driven up the banking sector's nonperforming loan ratio, Dong told the Global Times on Sunday.

Therefore, "In line with the central government's agenda to optimize assets structure, domestic banks might refrain from issuing loans to those SOEs that are plagued with overcapacity," Dong said.

In addition to some SOEs, the highly leveraged and overinflated property sector is likely to be another target for commercial banks, Liu Xuezhi, a senior analyst at Bank of Communications, told the Global Times on Sunday.

Dong also pointed out that the central government would take shots against commercial banks' off-the-balance sheet (OBS) activities this year, preventing them from participating too extensively in the capital market. OBS generally refers to assets or liabilities that do not appear on a company's balance sheet but are nonetheless assets or liabilities of the company such as shadow banking.

"Most of the OBS lending is speculative, highly leveraged and risky, which not only builds up systemic risks in the financial sector but also stems liquidity," he explained.

For example, the country's shadow banking industry, predominantly represented by two pillar instruments - wealth management products and trust products - is estimated to stand at $8.5 trillion, according to a Moody's Investors Service's estimate. In 2016, the sector grew by around 20 percent.

Similar to the banking sector, the central government is also expected to guard against insurers' risky investment in the capital markets, Liu predicted.

Chain reaction

However, the deceleration of OBS activities, which led to a withdrawal of money from the Chinese capital market, would send down A-share prices in a gradual manner and rattle bond markets, Dong said, describing the effect as a chain reaction. He also noted that the expansion of commercial banks' assets volume will slow down in upcoming years.

Liu agreed, noting, "The financial service sector's contribution to the country's GDP growth may decline a little bit this year from the 8 percent of 2016."

But experts believe that the overall benefits are worth the short-term retreats.

"In the long term, the government's tightened scrutiny could bring down the high leverage of the financial sector and propel stabilizing growth," Dong stressed.