China Said to Plan Crackdown on Banks’ Loan Limit Evasion

China has drafted rules banning banks from evading lending limits by structuring loans to other financial institutions so that they can be recorded as asset sales, two people with knowledge of the matter said.

The regulations drawn up by the China Banking Regulatory Commission impose restrictions on lenders’ interbank business by banning borrowers from using resale or repurchase agreements to move assets off their balance sheets, said the people, who asked not to be identified because they aren’t authorized to discuss the rules publicly. Banks would also be required to take provisions on such assets while the transactions are in effect.

The rules would add to measures this year tightening oversight of lending, such as limits on investments by wealth management products and an audit of local government debt, on concerns that bad loans will mount. The deputy head of the Communist Party’s main finance and economic policy body warned last week that one or two small banks may fail next year because of their reliance on short-term interbank borrowing.

“China’s banks and regulators are playing this cat-and-mouse game in which the banks constantly come up with new gimmicks to bypass regulations,” Wendy Tang, a Shanghai-based analyst at Northeast Securities Co., said by phone. “The CBRC has no choice but to impose bans on their interbank business, which in recent years has become a high-leverage financing tool and may at some point threaten financial stability.”

The CBRC’s press office didn’t immediately respond to requests for comment by e-mail and fax.

Risk Requirements

The proposed rules target a practice where one bank buys an asset from another and sells it back at a higher price after an agreed period. Chinese banks are expanding transactions with other financial institutions, known as FI business, which have lower risk-capital requirements, Australia & New Zealand Banking Group Ltd. economist Li-Gang Liu wrote in a report today.

“Many banks started to build up their FI business to escape the internal risk controls and the yet-to-catchup regulations,” Liu wrote. “The CBRC is likely to issue regulations requiring banks to put high capital reserves on banks’ FI business.”

Interbank assets at Chinese banks whose shares are traded in Hong Kong surged 140 percent in the three years through mid-2013, led by medium-sized lenders such as China Minsheng Banking Corp., according to Citigroup Inc. Banks channel funds from other institutions into corporate loans, booking them as interbank assets to avoid regulatory requirements such as loan quotas, capital requirements and the loan-to-deposit ratio cap, analyst Simon Ho wrote in a Nov. 15 report.

Lending Cap

The proposed regulations would also limit a bank’s total lending to other financial institutions to 50 percent of its total deposits, and cap loans to non-bank financial companies at 25 percent of its net capital, according to the people. The rules, once approved, would take effect in February, they said.

Increasing reliance on short-term interbank funding to finance long-term loans this year prompted China’s worst credit crunch, when the benchmark overnight money market rate reached a record on June 20.

If the CBRC requires banks to take a 30 basis-point provision for certain interbank exposures, earnings for most publicly traded banks would be cut by less than 1 percent, Mike Werner, a Hong Kong-based analyst at Sanford C. Bernstein & Co., wrote in a Nov. 14 note. Minsheng’s profit could be lowered by more than 4 percent, he estimated.

Interbank Funding

Mid-sized Chinese banks got 23 percent of their funding and capital from the interbank market at the end of 2012, compared with 9 percent for the largest state-owned banks, Moody’s Investors Service said in June. The ratings company forecast a further increase in non-performing loans as weaker borrowers find it hard to refinance.

Credit quality started to deteriorate in late 2011 as borrowers took on more debt to service their obligations amid a slowing economy and weaker income. Policy makers encouraged a $6.6 trillion credit binge during the past five years as stimulus to combat the global economic slowdown.

Nonperforming loans at Chinese banks increased for an eighth consecutive quarter in the three months ended Sept. 30 to 563.6 billion yuan, extending the longest streak in at least nine years. Still, they account for just 0.97 percent of the nation’s outstanding loans, according to the CBRC.

— With assistance by Steven Yang

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