Mid-tier Chinese banks piling up trillions of dollars in shadow loans

Bank of Jinzhou Co

31/01/2016 21:00

(Repeats Sunday story) 
    * Bank 'shadow loans' rose by third in H1 2015 
    * Packaging loans as investments masks banks' exposure 
    * Investment products are classed as lower risk than loans 
    * China bank regulator paying close attention to this 
practice 
 
    By Shu Zhang and Matthew Miller 
    BEIJING, Jan 31 (Reuters) - Mid-tier Chinese banks are 
increasingly using complex instruments to make new loans and 
restructure existing loans that are then shown as low-risk 
investments on their balance sheets, masking the scale and risks 
of their lending to China's slowing economy. 
    The size of this 'shadow loan' book rose by a third in the 
first half of 2015 to an estimated $1.8 trillion, equivalent to 
16.5 percent of all commercial loans in China, a UBS analysis 
shows. For smaller banks, the rate is much faster. 
    This growing practice, which involves financial structures 
known as Directional Asset Management Plans (DAMPs) or Trust 
Beneficiary Rights (TBRs), comes at a time when some mid-tier 
lenders, under pressure from China's slowest economic growth in 
25 years, are already delaying the recognition of bad loans. 
 urn:newsml:reuters.com:*:nL3N1353M8 
    "These are now the fastest growing assets on the balance 
sheets of most listed banks, excluding the Big Five, not just in 
percentage terms but absolute terms," said UBS financial 
institutions analyst Jason Bedford, a former bank auditor in 
China who focuses on the issue. 
    "The concern is that the lack of transparency and 
mis-categorization of credit assets potentially hide 
considerable non-performing loans." 
    To provide a buffer against tough times, banks are required 
to set aside capital against their credit assets - the riskier 
the asset, the more capital must be set aside, earning them 
nothing. 
    Loans typically carry a 100 percent risk weighting, but 
these investment products often carry a quarter of that, so 
banks can keep less money in reserve and lend more. 
    Banks must also make provision of at least 2.5 percent for 
their loan books as a prudent estimate of potential defaults, 
while provisions for these products ranged between just 0.02 and 
0.35 percent of the capital value at the main Chinese banks at 
the end of June, Moody's Investors Service said in a note last 
month. 
    At China's mid-tier lender Industrial Bank Co  601166.SS , 
for example, the volume of investment receivables doubled over 
the first nine months of 2015 to 1.76 trillion yuan ($267 
billion). 
    This is equivalent to its entire loan book - and to the 
total assets in the Philippine banking system, filings showed. 
    Industrial Bank declined to comment for this story. 
    Investment receivables may include such benign assets as 
government bonds, but increasingly they include TBRs and DAMPs 
at mid-tier lenders. 
    At Evergrowing Bank, investment receivables reached 397 
billion yuan in September, surpassing its loan book of 290 
billion yuan. The bank said last year practically all of its 
investment receivables were DAMPs and TBRs. 
 
    REGULATOR ON ALERT 
    China Zheshang Bank, another smaller lender, also saw its 
investment receivables double over the same period, the bank's 
prospectus to sell shares in Hong Kong shows. 
    Zhang Changgong, the bank's deputy governor, said banks were 
increasingly becoming return-seeking asset managers, not mere 
lenders. 
    "In the past banks (made loans and) held assets. Now banks 
manage assets," he said at a press conference in December. 
    The rapid growth of investment receivables, from less than 
$300 billion in 2012, comes despite a decision in 2014 by 
China's banking regulator to restrict purchase of TBRs and DAMPs 
under repurchase agreements in the interbank market, in a move 
to restrict the growth of these assets. 
    But DAMPs and TBRs soon reappeared on bank balance sheets 
under the line 'investment receivables'. 
    The China Banking Regulatory Commission (CBRC) is paying 
close attention to investment receivables, officials told 
Reuters. 
    China Guangfa Bank's Tianjin branch was fined last year for 
using its own funds to invest in a structured product that was 
providing $1.5 billion yuan in financing to a real estate 
company to avoid loan recognition and proper provisioning, the 
CBRC said in a note on its website. 
    The listing of Bank of Jinzhou  0416.HK , another small 
Chinese lender, nearly derailed last year when it revealed in 
documents prepared for the share sale that it was exposed to 
troubled solar company Hanergy Group  0566.HK , primarily 
through such products. urn:newsml:reuters.com:*:nL3N13I18N 
    The bank subsequently sold off the bulk of its risk. 
    To structure these deals, a bank typically engages a 
friendly trust, securities, or asset management company to set 
up a financing arrangement for a bank client. 
    The bank then buys the beneficiary rights to the investment 
product using a special purpose vehicle. Typically, the 
originating bank assumes all risk should the borrower default. 
    "If the originating bank does not promise to pay from its 
own pocket should any default happens, no trust company would 
agree to collaborate," said a senior executive at a Chinese 
mid-tier bank, who declined to be named due to the sensitivity 
of the issue. 
 ($1 = 6.5925 Chinese yuan renminbi) 
 
 (Reporting By Shu Zhang and Matthew Miller; Editing by Will 
Waterman; Editing by Lisa Jucca and Will Waterman) 
 ((matthew.miller1@thomsonreuters.com;)) 
 
Keywords: CHINA BANKS/INVESTMENT