[Banking Watch]
(8 March 2013)
Abstract
• After moderating in 2011, shadow banking activity has boomed again over the past year on the shift toward more growth-supportive policies.
While GDP growth has picked up and a hard landing has been averted, it has come at the cost of exacerbating domestic financial fragilities, including an increase in shadow banking activities. Against this background, this note takes stock of recent developments and updates our assessment of the associated risks to the broader financial system.
• Risks have increased as a result of the pickup in shadow banking activity, but they remain manageable.
As flagged in our previous work (see Banking Watch, November 2011), we see three risks associated with shadow banking activity: i) lending concentration, especially to real estate developers; ii) maturity mismatches given the short-term nature of funding vehicles; and iii) liquidity shortages from a siphoning off of deposits from the formal banking sector. The more recent rise in shadow banking activity has exacerbated these risks, notwithstanding a strengthening of regulations in 2011. At the same time, enhanced liquidity facilities of the PBoC and the government’s substantial fiscal resources and foreign currency reserves should help cushion the impact on the financial sector in the event that risks materialize.
• The recent growth of shadow banking has given rise to a number of high-profile disputes over investor losses in wealth management and trust company products with potential reputational risks to banks.
Central to such disputes is whether wealth management products (WMPs) carry implicit guarantees by their selling agents (typically banks) for impairment of the underlying assets, as some investors may have been led to believe. Such cases have the potential to undermine confidence in the shadow banking system and could put pressure on affiliated banks to assist by providing liquidity or taking losses.
• While there are risks, shadow banking has played a role in facilitating economic growth and financial development in an otherwise repressed financial system. Entrust loans and bank acceptances have assisted SMEs in obtaining credit, which the formal banking system has been unable to provide. In cases where the proceeds of WMPs have been used to invest in stocks and bonds, the system has acted as an intermediary between household savings and the capital market. In this regard, WMPs and trust company products may be precursors to a more formal wealth management industry, pending further financial liberalization.
• To avoid excessive risks, the authorities should press ahead with efforts to improve supervision of the shadow banking industry and accelerate broader financial liberalization.
In addition to pressing ahead with financial liberalization and strengthening regulations, the authorities should take steps in the near term to enhance disclosure and transparency requirements of WMP issuance and sales. As a complementary measure, the authorities need to improve the infrastructure for investors’ education and protection.
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