China Seen Risking Credit Market Crunch With Leverage Crackdown

Updated on
  • Central bank said to put limits on wealth management products
  • Haitong cites `risk of stampede' based on stock market history

Six months after a debt-fueled rally in Chinese equity turned into a $5 trillion rout, authorities are stepping up efforts to make sure the same thing doesn’t happen in the bond market. Analysts and investors are concerned the crackdown itself could be a risky move.

The People’s Bank of China moved to exert more control over wealth management products, which often invest in debt and are popular among investors seeking yields higher than on deposits. It told lenders Monday it will limit funds raised through the so-called WMPs that they can outsource to other financial institutions to manage, according to people familiar with the matter. The PBOC will also tighten control of leverage that banks take on when buying notes, the people said. External managers often borrow more aggressively for debt purchases, China Merchants Bank Co. said.

“There is risk to deleveraging when economic growth is slowing,” Haitong Securities Co. analysts led by Jiang Chao wrote in a report Tuesday. “If there is a limit on how much funds banks can give to third parties to manage, it means a lack of momentum for further leveraging. Based on the history of China’s stock market, there is risk of stampede.”

The steps highlight challenges for Chinese authorities as they attempt to prevent overheating in credit markets while keeping benchmark lending rates at record lows to boost the weakest economic growth in a quarter century. Investors have piled into riskier debt including WMPs despite warnings of a leverage-fueled bubble from local brokerages.

The PBOC didn’t respond immediately to a faxed inquiry.

Chinese banks have been scaling up their wealth management businesses as they vie for deposits. Standard & Poor’s estimates the banking sector’s outstanding off-balance-sheet WMPs grew by 35 percent to 13.6 trillion yuan ($2.1 trillion) in 2015, it said in a research note dated Jan. 28.

Outstanding repurchase agreements in the nation’s interbank bond market, used by debt investors to amplify their buying power, surged to 9.7 trillion yuan in December, the highest level since at least 2012.

This was not the first time the Chinese regulators moved to contain leverage in the credit market. China’s clearing house for exchange-listed debt expanded the conditions under which it can restrict financing in November.

Stock Echoes

“We saw violent deleveraging in the equity market in 2015, which didn’t end very well,” said Liu Dongliang, senior credit analyst at China Merchants Bank. “So I think the central bank will likely take more mild steps when dealing with the bond market leverage.”

China also warned the nation’s top banking executives that they could lose their jobs if they fail to keep risks under control, according to people familiar with the situation.

Shang Fulin, chairman of the China Banking Regulatory Commission, told an internal meeting last month that banks would be forced to restructure, inject new capital or change their senior management if key risk indicators fall outside "reasonable ranges," the people said, requesting anonymity because the contents of the speech weren’t made public.

“This is clearly aimed at controlling risks in the banking sector," said He Xuanlai, Singapore-based credit analyst at Commerzbank AG.

Unwinding Eyed

While some of the cash from WMPs facilitate off-balance-sheet lending though repackaged loans, 44 percent was invested in bonds or money-market instruments at end-2014, according to the China Banking Wealth Management Registration System.

“As investors unwind positions to meet regulatory requirements, liquidity is likely to dry up in the next few weeks, weighing on bond market performance," Commerzbank’s He said. “The PBOC may also need to inject additional funds into the market to offset the de-leverage."

The central bank injected an unprecedented 1.235 trillion yuan via open-market operations in January before the Chinese New Year holidays next week. The one-month Shanghai Interbank Offered Rate, a gauge of funding availability, climbed to 3.2 percent on Jan. 29, the highest level since July, before dropping to 3.1 percent Wednesday.

“It’s certainly negative to the market if the regulators roll out measures,” said Ming Ming, chief fixed-income analyst at Citic Securities Co. “A lot of bond buying last year came from demand from wealth management funds, and the new measures could change the supply and demand balance.”

— With assistance by Heng Xie, Lianting Tu, Helen Sun, and Steven Yang

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