- Growth in China's shadow banking sector is falling
- But the borrowing is just moving around
China is on a drive to reduce its reliance on debt, a habit that some experts warn could lead to a global financial crisis.
An apparent recent victory in that push is new data suggesting that the growth in the risky "shadow banking" sector is slowing this year. But that might not be as good news as it seems on first blush: The credit is just moving to more regulated areas, keeping overall lending activity high.
Here's a break down of what you need to know:
What is shadow banking in China?
Shadow banking refers to activities performed by financial firms outside the formal banking sector, and therefore subject to lower levels of regulatory oversight and higher risks. Such activities are off the balance sheets due to accounting practices.
There have been worries that such practices mask the amount of risk that banks and other financial entities, such as insurance companies, are taking on. Those debt concerns have led some to claim that shadow banking in the Chinese economy could eventually lead to a financial crisis if the bubble pops.
According to a recent Moody's report, broad shadow banking levels in China "barely grew" to 64.7 trillion yuan ($9.72 trillion) at the end of the first half of 2017 from 64.4 trillion yuan ($9.7 trillion) at the end of 2016.
Earlier this month, Reuters calculations showed combined trust loans, entrusted loans and undiscounted bankers' acceptances — all common forms of shadow banking finance — fell to 107 billion yuan ($16 billion) in October from 396 billion yuan ($60 billion) in September.
The data, however, doesn't seem to be quelling concerns — not least from the Chinese regulators themselves — about a major credit event spreading to global markets.
Their concern is that debt isn't going away, it's just moving around: One reason for a fall in risky loans is that credit is being re-channeled into more formal and more regulated sectors.
Still, that could be a "silver lining," said Vishnu Varathan, head of economics and strategy at Mizuho Bank.
"One thing they got right is that they're getting away with the shadowy aspect of it, so more of it is going through formalized banking channels," he told CNBC.
New loans extended by Chinese banks reached 11.82 trillion yuan ($1.78 trillion) in the first 10 months of this year against last year's record 12.65 trillion yuan ($1.9 trillion), central bank figures show.
How has the official crackdown affected shadow banking?
On Friday, China's central bank took a new step in curbing debt by announcing new regulations that tighten rules on the 102 trillion Chinese yuan ($15.3 trillion) asset management business — which contributes greatly to the shadow banking industry.
That was just the latest stage of a crackdown from Beijing that has begun to show some signs of success.
Broad shadow banking levels "barely grew" to 64.7 trillion Chinese yuan ($9.72 trillion) at the end of the first half of 2017 from 64.4 trillion yuan ($9.68 trillion) at the end of 2016, a Moody's report released in November showed.
However, the growth in certain activities classified as "core" shadow banking accelerated to 18.2 percent from a year ago at the end of the third quarter of 2017, the reported added.
Undiscounted bankers' acceptance, a short-term debt product in the "core" category, for instance, returned to positive territory for the first time in three years, said Moody's.
The various "core" components are captured by Total Social Financing (TSF) data, an official gauge that provides a measure of credit and liquidity supplied by the entire financial system in China.
Non-"core" components, meanwhile, are not part of the TSF and are based on the issuance of higher-risk instruments such as wealth management products and asset management plans. These are the targets of the recent crackdown.
In assessing China's shadow banking sector, Moody's determined that debt in the country was moving into "comparatively better regulated parts," which improves transparency "and may increase the system's resilience to unexpected shocks."
Moody's latest report followed similar findings from Fitch a month earlier about China's shrinking shadow banking sector.
"Overall, China has been able this year to keep the off-balance-sheet or shadow banking activities slow," said Ben Luk, global macro strategist at State Street Global Markets.
On Thursday, central bank advisor Sheng Songcheng said at a finance forum in Beijing that he expects China's financial deleveraging to be less forceful next year as it has already achieved obvious results, Reuters reported.
Chinese regulators warn on debt
Despite headline figures about debt reductions in the country, there are major concerns over whether China will be able to keep it from eventually bubbling over.
Outgoing Chinese central governor Zhou Xiaochuan raised the issue when he highlighted high leverage levels in the country earlier this month.
"High leverage is the ultimate origin of macro financial vulnerability," wrote Zhou, who has indicated he is serving his last term in office after 15 years at the helm of the People's Bank of China (PBOC).
"This manifests as excessive debt in the sectors of real economy and as overly rapid credit expansion in the financial system," he added.
At the end of 2016, China's leverage ratio in the macro economy was 247 percent of GDP, while leverage in the corporate sector reached 165 percent of GDP. Debt risks are particularly worrisome in state-owned enterprises, which have been slow to reform, he added in an article warning of "hidden [but] sudden, contagious and hazardous risks]."
After all, it's not just a matter of regulation, as lenders will always look for creative ways to sidestep new rules.
Regulation spurs innovation
"Some shadow banking products are not transparent, and regulatory measures tend to end up encouraging financial innovations for evading tighter regulations," said Moody's.
For instance, under recent scrutiny are negotiable certificates of deposits (NCD), a kind of short-term bond, and niche products like perpetual notes, a long-term debt instrument that can be listed as equity rather than debt on balance sheets. The PBOC said it will start to include NCDs in its quarterly risk assessments next year.
"Overall, it means that the PBOC is following the 19th Congress's mandate to stabilise the financial sector during the financial sector clean-up," Iris Pang, Greater China economist at ING, said in a Monday note.
Pang added that the government controls on the NCDs are "just the first steps to control the growth of shadow banking," and she expects more rules to come.
"It's a bit of a hide and seek [as] they're looking for a Goldilocks here," Mizuho's Varathan added, explaining that a hard-line crackdown on leverage in the system could too-rapidly cool the Chinese economy, leading to a so-called hard landing.