China Is Getting Serious About Its Crackdown On Shadow Banking

REUTERS/Bobby Yip

China's State Council has issued a new set of guidelines - known as Document No. 107 - to curb the country's massive shadow banking system.

Only senior executives received the document. Societe Generale's Wei Yao thinks it is a "trial balloon, in order to gauge the potential response of financial institutions and so probably still open to further revisions."

Here's a breakdown of what the policy targets according to Yao:

1. "Unlicensed unregulated credit intermediation (such as via online finance companies)."
2. "Unlicensed but lightly regulated credit intermediation (such as via credit guarantee companies and micro-credit companies)."
3. "Licensed but insufficiently regulated financing activities (including those conducted by money market funds, informal asset securitization and some wealth management businesses)."

Meanwhile, the China Banking Regulatory Commission (CBRC) issued a draft of its document no 9 late last year which is focused on shadow banking activities that are "disguised as interbank activities," writes Yao.

The latest Chinese debt audit showed that local government debt has ballooned to 17.9 trillion renminbi ($2.8 trillion), from 10.7 trillion renminbi in 2010. That's up nearly 67%.

Rising local government debt has had many concerned about an impending financial crisis in China. And shadow banking has been one of the main sources of credit for local governments.

Part of the problem is that local governments borrowed from commercial banks and trusts which have high interest rates and short durations, about six months to three years. But these have been used to finance long-term construction projects, many of which don't pay off. "Document No. 107 would also be a logical step of managing local government debt risk," writes Yao.

This also comes on the back of two spikes in money market rates, one in June and one in December. On both occasions it was argued that the People's Bank of China was pushing for tighter liquidity conditions.

Yao previously pointed out that China's credit growth had been slowing and that Chinese officials are trying to "engineer a gradual deleveraging process."

Patrick Chovanec at Silvercrest Asset Management thinks those making this argument are being optimistic. He points out that total credit growth has been up 20% this year from an already high base. "China's leaders are riding a runaway train that they don't quite know how to stop. And they're running out of track," he wrote in a Bloomberg View column.

Yao believes that if document 107 is confirmed, it supports her call for engineered deleveraging, which in turn will have a short-term negative impact of growth. Though all of this is key to more balanced economic growth.