Non-bank credit financing risks remain manageable

The rapid expansion of non-bank credit financing in China has rekindled concerns about rising financial and fiscal risks. However, we believe these risks remain manageable for now.

Increased corporate bond issuance and a revival of "shadow banking" activities have become important sources of financing, supporting the stabilization of economic growth in the country, despite lower-than-expected new bank loans in recent months.

The booming bond market reflects the government's promotion of direct financing, which should reduce the reliance on the banking system, diversify risks, and improve the efficiency of resource allocation.

Total social financing has risen to 13 trillion year-to-October, and could reach around 15 trillion (representing 26 percent of GDP) in 2012. The share of bank credit in total social financing is now 55 percent, down from the 58 percent in 2011 and 70 percent in 2008, while that of debt financing has jumped to 14.3 percent from 9.5 percent and 8 percent respectively. Off-balance sheet lending has stayed at around 20 percent.

On the other hand, there are renewed concerns about the financial and fiscal risks associated with the rapid expansion of non-bank credit financing. Two types of risk are frequently mentioned. First, risks from the sizable trust and entrusted loans; Second, risks from a rebound in local government investment vehicles' (LGIVs) borrowing, this time from the bond market and trusts rather than from banks as in 2009 and 2010.

2012 has seen a revival of trust financing after regulatory curbs introduced since mid-2010 muted activity. Trust sector assets under management have risen from 4.8 trillion in 2011 to 6.3 trillion by the third quarter, with a significant amount of lending to developers or LGIVs that can't access bank credit. More than 35 percent of trust assets represent funding for infrastructure and real estate construction. Property-linked trusts account for 677 billion, or 11 percent of the total.

On the back of efforts by local governments to stabilize growth amid falling fiscal revenue growth, 2012 also saw a surge in LGIV bond issuance, totaling 927 billion by October. More than half of the funds raised were used for capital goods investment (ie, building and construction projects), followed by transportation (ie, highways, airports, 19 percent). This is in addition to the 10.7 trillion yuan (27 percent of GDP) total local government debt by end-2010.

While some isolated (de facto) defaults are likely and probably should be welcomed, overall, the systemic financial or fiscal risks from elevated trust and entrusted loan levels and the rising LGIV borrowings are manageable for now. This is because of strict regulatory, the structure of the loans, and the still solid central government fiscal positions.

Both trust and entrusted loans have limited direct-risk exposure to the banks. Banks' direct involvement in trust lending is low, except for the development of "Bank-trust cooperation products" which are strictly regulated. Such products now account for 20 percent of banks' total wealth management products (WMPs), according to the 2012 KPMG survey. In other cases, banks act mostly as distributors of WMPs. In a typical developer trust, a trust company provides funds to a project company by selling WMPs to high net-worth clients. Banks act purely as intermediaries for entrusted loans, and hence are not subject to credit risks.

However, a source of concern is that risks may be artificially suppressed by some form of debt restructuring: rolling over debt via the issuance of new products or buyouts by asset management companies. A de facto default of a property trust issued by Jilin Province Trust happened in May when it delayed payments by eight days (subsequently it was bought by a State-owned asset management company). Shandong Helon, a textile company on the verge of defaulting on 400 million yuan of commercial paper in April, was rescued by banks after local government intervention. Such buyouts/bailouts may create a false sense of security, reinforcing the belief of an "implicit government guarantee". The underestimation of the credit risks in both the trust loans and bond markets could induce excessive risk-taking.

The author is China economist at Barclays Capital Asia. The opinions expressed here are entirely her own.