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​China To Shore Up Financial System Risk

Through December 23, the China Banking Regulatory Commission (CBRC) is accepting public opinion on how to reform its regulatory measures within the Chinese banking sector.

The central goal of the measure will broaden the country’s regulatory framework to reel in the burgeoning level of shadow banking activity that escapes normal rules and regulations. To do so, the CBRC is expanding its definition as to what constitutes an off-balance-sheet transaction and acknowledging additional business models and types that engage in these activities.

For now, several details still need to be hashed out. For example, we do not know how each bank will be individually affected given risk limits and approval of off-balance-sheet activities are managed by each institution’s board of directors. The CBRC also has not provided particulars regarding capital ratios, credit conversion factors, reserve requirements and other specifics that will outline the degree of regulatory pressure exerted. Moreover, we also don’t know whether the credit risk affiliated with offloaded assets will remain within the financial system (i.e., with the offloading bank) or within the shadow banking system.

The risk within the Chinese financial system remains enormous for the time being. Since the end of the last US recession in Q2 2009, credit derived from Chinese issuers in the non-financial sector has expanded 38.9% annualized. This is far beyond the aggregate rate of GDP growth, which is below 10% and currently growing at 6.7%.

(Source: Bank for International Settlements; modeled by fred.stlouisfed.org)

Shorting Chinese financials (CHIX) is likely not the sharpest idea, given the economy is still growing at nearly 7% per year and can remain that way for perhaps the next few years. But given the rapid expansion of credit in the Chinese economy relative to the country’s income, remaining position-less with respect to the Chinese banking sector is likely the best solution.