May 11 (Bloomberg) -- A Chinese central banker urged tougher rules to rein in shadow banking as its unchecked growth has helped drive up borrowing costs and threatens to undermine the financial system in the world’s second-biggest economy.
Financial innovation in the interbank market and wealth management products has often been aimed at evading regulations on issues such as risk provisioning and capital adequacy, Liu Shiyu, deputy governor of the People’s Bank of China, said at a forum in Beijing yesterday.
China’s authorities have stepped up efforts to curb the more lightly regulated shadow banking industry as they seek to rein in total debt that’s surged to more than double gross domestic product. Shadow financing, estimated at 46.7 trillion yuan ($7.5 trillion) by JPMorgan Chase & Co., has made it harder for the government to curtail credit and shield state banks from rising defaults as the economy cools.
“If everyone in society is trying to get into the financing business, we may have entered a phase where a fever has started to affect our ability to think,” Liu said, “We must make up our minds to rectify interbank operations and all kinds of wealth management products.”
Shadow banking in China, which includes interbank borrowing and wealth management products, creates a “gambling” mindset, with funds channeled into short-term investments, PBOC’s Liu said. It pushes up costs for the real economy and makes zero contribution to improving labor productivity, he said.
Investors may be offered an 8 percent yield on a wealth management product, Liu said. The layers of fees and extra interest charged by intermediaries can push the interest rate for the end borrower up to 14 percent, Liu said.
“Under such circumstances, no one will buy stocks because stocks are risky while money made from wealth management and the interbank markets are risk-free,” he said.
The State Council, China’s cabinet, warned last week that the nation’s capital markets are still immature and some organizational and systematic problems still exist.
Financial institutions have become increasingly involved in the interbank market, raising short-term debt and using the funds to make long-term loans to companies. That’s allowed banks to circumvent capital adequacy rules, lending quotas and restrictions on lending to real estate companies and local government financing vehicles.
A cash crunch in China’s money markets in June last year forced two branches of China Everbright Bank Co. to delay repaying 6.5 billion yuan of short-term interbank loans on time after they failed to receive proceeds from counterparties, underscoring the risks of the practice.
The Chinese Academy of Social Sciences, a state-run research institute, described the interbank market as a “critical link” that could exacerbate financial-system risks in times of liquidity shortage, according to a report in the China Daily yesterday.
The China Banking Regulatory Commission last month stepped up supervision of the trust industry by tightening the approval process for companies seeking to enter new businesses and offer new products. It also told smaller rural banks to limit investment in assets that aren’t traded on any exchanges using proprietary or interbank funds.
The regulator acted after the State Council in December imposed limits on shadow banking in the highest-level effort so far to control off-balance-sheet lending. They included a ban on transactions designed to avoid regulations such as moving interbank lending off balance sheets.
“Expansion of shadow banking will bring more evasion of regulations and more arbitrage,” Wang Zhaoxing, a vice chairman of the CBRC, said yesterday at the same conference where Liu spoke. “Shadow banking without regulation or transparency can seriously endanger financial stability and security,” he said, without specifically referring to China.
China’s total debt, including government, corporates, financial institutions and households, was about 226 percent of GDP last year, according to estimates from Credit Agricole SA, which projects the ratio will rise to 265 percent in 2016. The ratio has risen from 105 percent in 2000 and 187 percent in 2012.
The increase, spurred by the government’s 4 trillion yuan stimulus package in 2008 to support the economy amid the global financial crisis, has evoked comparisons with debt surges that tipped Asian nations into crisis in the late 1990s and preceded Japan’s lost decades.
China’s government debt, including that of the central government, local government and financing vehicles, will increase as investment is still needed to support growth, Liu said. “You won’t get rid of them or you can’t get rid of them,” he said.
The world’s second-largest economy grew 7.4 percent in the first quarter, the least since 2012, and is forecast to expand 7.3 percent this year, the weakest pace since 1990, based on the median estimate in a Bloomberg News survey last month.
The economic slowdown has hurt borrowers’ ability to repay debt and driven up banks’ bad loans. Nonperforming loans at Chinese lenders increased for a ninth straight quarter to 592.1 billion yuan as of December to the highest level since 2008, CBRC data show.
Chinese banks wrote off 120 billion yuan of bad loans in 2013, implying that profit from 4 trillion yuan of loans was wiped out, Liu said.
--With assistance from Nerys Avery in Beijing.