China’s financial leverage: An endless cat and mouse game continues to benefit large banks - Natixis

Alicia Garcia Herrero, Chief Economist at Natixis, explains that this is not the first time Chinese banks find themselves in the regulatory whirlpool as from the usage of repo agreements to wealth management products (WMPs), and most recently negotiable certificate of deposits (NCDs), they have been very creative in playing the cat and mouse game in front of evolving regulations.

Key Quotes

“There are now also more regulations targeted at NCDs, which are short-term, non-collateralized paper with an even higher funding cost than the SHIBOR. This has led to a fall in issuance, but has grown again since June 2017. The underlying reasons could probably be a lack of other options and the regulations are not as tight as they may appear on the surface. In fact, the PBoC’s pressure affects banks very differently. It penalizes banks short of liquidity and benefits those long of liquidity. This simply means that China’s five largest commercial banks (all state-owned) are the winners while the others are the losers.”

“As liquidity is increasingly expensive, liquidity scarce banks have also developed new ways to bypass regulations through money market funds (MMFs), which have reached 5.86 RMB trillion in a very short period of time. The quick pace of expansion may pose extra liquidity risks especially when three-quarter of the assets have a maturity less than 90 days.”

“Beyond the – probably unintended – push for financial innovation, the PBoC’s regulatory move is also pushing further the duality of China’s banking system. When small banks are struggling for liquidity, large banks stand to benefit from the regulatory crackdown. The latest 2017 Q2 results have confirmed our expectations that large banks can gain from regulatory arbitrage and risks are rising for smaller banks. In other words, the improvement in bank results is not only due to better economic conditions but also to regulatory arbitrage.”