20140314-美银美林-Shadow_banking__demystifying_entrusted_loans_17页_1mb

Summary of Shadow Banking: Demystifying Entrusted Loans

Core Content

This report by Bank of America Merrill Lynch provides an in-depth analysis of entrusted loans in China, highlighting their role as a significant component of the shadow banking system. As of February 2014, entrusted loans reached RMB9.3tn, representing approximately 12% of the banking sector's on-balance sheet loans and 9% of total credits in China. It is the second-largest component of Total Social Financing (TSF), and has shown a notably higher growth rate compared to other shadow banking activities.

Main Points

• Definition and Structure: Entrusted loans are financial instruments where non-bank entities (governments, corporates, individuals) lend to other entities with commercial banks acting as trustees. These loans are distinct from traditional bank loans as they are considered a transfer of credit rather than direct lending.

• Types of Entrusted Loans:

  • Government Lending: Includes mortgage loans from Housing Provident Funds, making up over 20% of the market.
  • Intragroup Cash Allocation: Used by large corporations to transfer funds between subsidiaries.
  • Interest Rate Arbitrage: SOEs borrow at low rates and lend to developers at higher rates.
  • Packaged into WMPs: Brokers and TAMCs (Targeted Asset Management Companies) have increasingly packaged entrusted loans into wealth management products (WMPs), which have contributed nearly RMB1tn in new entrusted loans over the past year.

• Growth and Risks:

  • Entrusted loans have grown at a faster rate than trust loans and corporate bonds, reaching a 40% YoY growth by February 2014.
  • The report highlights concerns about rising credit risks in the system, particularly in WMPs, and warns of potential defaults.
  • Despite these risks, the report concludes that a systemic crisis is not imminent, with stress tests indicating that even a 50% impact on the balance sheet would not cause significant issues.

• Regulatory Context:

  • Regulators have been relatively lenient with the first three types of entrusted loans, considering them as "transfer of credit" rather than direct credit creation.
  • However, the new WMP-type entrusted loans require more oversight due to their potential risks.
  • The "No. 8 Article" imposes caps on non-standard credit assets (NSCAs) in WMPs, limiting them to less than 35% of total WMP size and 4% of bank assets.
  • The "No. 124 Article" introduced in July 2013 restricts TAMCs from guaranteeing principal or yield and requires minimum asset size for cooperating banks.

Key Information

• Market Exposure: CIB, CNCB, and HXB are the most exposed to entrusted loans, with exposure levels ranging from 14% to 19% of their on-balance sheet loans.
• TAMCs: As of February 2014, there were 64 TAMCs with total registered capital of RMB3.0bn. Most have minimal capital, with only 5 TAMCs having registered capital over RMB100mn.
• Financial Innovation: The report discusses an innovative structure to bypass the NSCA cap by using interbank deposits, effectively disguising entrusted loans as interbank transactions.
• Case Example: A CITIC-COFCO entrusted loan WMP is highlighted, where COFCO Property borrows RMB0.91bn from CITIC TAMC, offering a 7.8% annualized return to investors.

Risk Assessment

• Default Risk: The report notes that the exponential growth of WMPs and rising credit risks could lead to potential defaults in the coming months.
• Regulatory Tightening: The authors recommend enhanced transparency and capital requirements for TAMCs to mitigate risks.
• Systemic Risk: While not a current systemic risk, the report warns that without proper regulation, the situation could evolve.

Conclusion

Entrusted loans are a significant and rapidly growing part of China's shadow banking system. They offer a way to channel credit to various sectors, including SMEs and property developers, but also pose credit risks. The report emphasizes the need for regulatory tightening, especially around TAMCs and WMPs, to ensure stability and transparency in the financial system.