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China Ups the Ante in Bid to Quash Financial Risk: QuickTake Q&A

It looks like China is finally getting real about risks lurking in its financial system. Stock markets on the mainland slumped in April and government bond yields spiked as regulators overseeing banking, insurance and securities trading issued a flurry of directives, coming down on everything from excessive borrowing to speculation in equities. While de-risking has been the government’s mantra since 2015 -- when whiplash moves in Chinese shares ignited global turmoil -- the country’s most powerful politicians are now weighing in, ordering a comprehensive check of financial markets.

1. Why is this time different?

President Xi Jinping chaired a gathering to discuss “safeguarding national financial-market security” on April 25, a day after the worst losses this year in Shanghai-traded shares. The meeting was attended by members of the 25-person politburo, made up of the top politicians in China. While the central bank governor and the various regulators were also there, the fact the Communist Party’s premier decision-making body met and decided to act on financial risk means there’s consensus at the very top and things are about to change.

2. What are they worried about?

China built up a record debt pile in the wake of the global financial crisis as it leveraged its way to a stable and strong growth rate. With liabilities equal to about 264 percent of gross domestic product, according to Bloomberg Intelligence estimates, debt poses a systemic risk to China. The country’s shadow banking sector has ballooned, with wealth-management products tripling to $3.8 trillion in just three years. WMPs have grown in popularity because they offer higher yields than those offered on other assets in the current low-interest rate environment. The rapid unwinding of trades funded with margin debt fueled the $5 trillion equity market slump in 2015 as well.

3. What have the regulators done so far?

  • August 2016-present: The People’s Bank of China starts offering funds to banks at longer tenors and boosting money-market rates (twice so far in 2017) as a way of deterring companies from borrowing.
  • March 2017: The banking regulator asks lenders to submit reports on entrusted investments -- funds that Chinese banks farm out to external asset managers -- by June 12. They need to rectify any irregularities involving high leverage, multiple layers of investment or regulatory arbitrage by Nov. 30, according to a document obtained by Bloomberg News.
  • April 7: China says it will issue guidelines on how to improve banks’ efficiency in serving the real economy, requiring lenders to speed up bad loan disposal and crack down on illegal funds flowing into the real estate sector, Yang Jiacai, assistant chairman at the China Banking Regulatory Commission (CBRC), says at a briefing.
  • April 9: China’s anti-graft agency says it is investigating Xiang Junbo, the former chairman of the China Insurance Regulatory Commission, on suspicion of “severe” disciplinary violations. Xiang was sacked from his position, the Xinhua News Agency reported.
  • April 10: The CBRC issues guidelines on stepping up risk control in the banking industry, requiring lenders to ensure stable asset quality, improve liquidity risk management, strengthen their bond and investment businesses and improve interbank operations.
  • April 12: The CBRC issues a notice saying it plans to tighten scrutiny over banks’ shareholders, as part of wider efforts to plug regulatory loopholes. The statement lists 26 rules that are being drafted, or that the regulator intends to draft. 
  • April 14: The Shanghai Stock Exchange says on its Weibo social-media feed that it sent warnings to 130 investor accounts and suspended 13 because they may have engaged in speculative trading of shares linked to the new Chinese economic zone, Xiongan. The exchange also cautions that sharp declines usually follow quick advances driven by speculation.
  • April 15: China Securities Regulatory Commission Chairman Liu Shiyu calls on the country’s equity exchanges to “show swords” and crack down on behavior that disrupts market order “without mercy.”
  • April 21: The CSRC’s spokesman says in a press briefing that the agency fined a former official at the Shenzhen Stock Exchange 251 million yuan ($36 million) for illegal equity trading activities.
  • April 25: Wang Baoan, former head of China’s National Bureau of Statistics, is indicted on suspicion of accepting bribes, according to Xinhua.

4. How is this being felt in the markets?

The run of measures spooked stock investors, prompting them to sell mainland shares amid anxiety over how far the crackdown will go. There’s concern Beijing will start allowing more credit defaults. Banks have also started pulling money out of entrusted investments, forcing non-lender institutions to sell their bond and equity holdings. The Shanghai Composite Index fell more than 4 percent from a peak reached on April 11 and the selloff in Chinese bonds spurred by the money-market tightening also got a second wind, with yields on 10-year government debt jumping to their highest level since August 2015.

5. What happens next?

Now that it has the politburo’s backing, the campaign to reduce financial risk will probably be stepped up. Financial News, a publication run by the central bank, said in a front-page commentary April 24 that more de-leveraging measures are likely to be introduced. Such a campaign, particularly if it’s not well coordinated, could trigger credit events, sudden periods of tight liquidity and an uptick in volatility in the short term, UBS Group AG economists said in an April 26 note. The market correction may have further to run, with China’s economic recovery giving authorities confidence to ramp up de-leveraging, says Ken Peng, an investment strategist at Citigroup Global Markets Asia. That said, the government will want some level of market stability ahead of a twice-a-decade Communist Party leadership reshuffle later this year.

The Reference Shelf

  • A QuickTake explainer on China’s ticking debt bomb.
  • QuickTake Q&As on China’s entrusted bonds and WMPs.
  • The stock selloff defied bullish sentiment elsewhere.
  • Chinese think the government will bail out the WMP sector.
  • Shadow banking has shrugged off de-leveraging, so far.
  • Ex-finance minister says local governments should be allowed to default.
  • The Chinese government’s English portal.

— With assistance by Tian Chen, Dingmin Zhang, and Jun Luo

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