11 March 2018

The hidden risks of China's war on debt

HENNY SENDER

HONG KONG -- When the Bank of Jinzhou, based in China's northeastern rust belt, went public on the Hong Kong stock exchange two years ago, its finances were a wreck. It had issued 34 billion yuan ($5.36 billion) worth of "wealth management products" that are hallmarks of China's sprawling "shadow" banking sector, and it was owed 9 billion yuan by an unnamed borrower who was under investigation by Hong Kong regulators. The bank, like many others across China, was loaded with risky debt -- the kind that China's leadership in Beijing is now determined to stamp out.

After a massive buildup over the past decade, the government is waging an all-out war on debt. In December, President Xi Jinping said slashing debt was one of the "critical battles" Beijing would fight over the next three years, along with reducing pollution and poverty. Regulators have cracked down on the shadow banking sector, and the government has put the brakes on Anbang Insurance Group, HNA Group and Dalian Wanda Group, conglomerates that spent billions on debt-fueled acquisition sprees for trophy assets around the world. On Feb. 23, regulators charged Anbang founder Wu Xiaohui with fraud and embezzlement and officially took over its operations.

Together, such efforts have sent a strong message about Beijing's determination to purge the financial system of excessive risk-taking -- a message that is expected to be driven home when the National People's Congress begins March 5. In the process, regulators have helped ease fears that China's debt mountain would lead to a systemic crisis on the order of the 2008 global financial meltdown or the 1997 Asian financial crisis.

For all this progress, however, fears remain. First, there are lingering concerns over the sheer size of the China's debt pile, which UBS estimates represented 272% of GDP at the end of 2017. But there are also growing worries about the potential unintended consequences of the authorities' efforts to rein in that debt.

The regulatory chill is already having an impact on businesses large and small. Chinese direct investment in North America last year fell 35% from 2016 as a result of the official crackdown on the leveraged purchases of assets such as luxury hotels, premier sports teams and Hollywood studios, according to a report from law firm Baker McKenzie and Rhodium Group, a consultancy.


The Bank of Jinzhou raised over $5 billion through risk-laden "wealth management products."© AP

China's smaller enterprises, many of which had relied on the unregulated shadow banking system for credit, have also been squeezed.

"The effect of intensified regulation is no longer limited to de-risking the financial sector but is now beginning to impact the supply of credit to the real economy," said Michael Taylor, chief credit officer for the Asia-Pacific region at Moody's Investors Service.

The tightening is the major reason analysts have downgraded their forecasts for Chinese growth from 6.9% last year to between 6.6% and 6.7% this year, even as export orders pick up on the back of a global recovery.

Whatever impact the debt crackdown is having on the real economy, regulators remain determined to kill shadow banking activity. They have made progress: In 2017, total shadow banking asset growth was about a tenth that of 2016, according to estimates from Moody's. 


But Bank of Jinzhou and other second- and third-tier banks across China are among those that still pose challenges. Prior to its listing, Bank of Jinzhou seemingly violated every rule of prudent banking. Lending money, which should be the core activity for such banks, was only a small part of what it did. Instead, it invested in and sold the high-yielding, complex wealth management products that the China Banking Regulatory Commission (CBRC) has been attempting to rein in as part of its attempt to control shadow banking.

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