The surge in investments in loans and receivables by Chinese banks, while supportive of earnings and capital generation in the short term, raises asset quality, liquidity and interest rate risks in the long term, says Moody’s Investors Service.
Data from the 26 listed banks themselves shows that investments in these asset classes jumped to RMB10.5 trillion at end-2015 from RMB2.5 trillion at end-2012, led by joint-stock commercial banks and regional banks, according to Moody's just-released report "Chinese Banks -- Investments in Loans and Receivables Increase System Risks.”
"The high yields and low provisioning costs of these investments have enabled continued earnings growth for these banks in an environment of rising credit costs and declining net interest margins," says David Yin, a Moody's Assistant Vice President and Analyst.
"However, the specific features of these investments mean they may obscure the true extent of the banks' exposure to the ultimate borrowers, while the lower provisioning and capital requirements reduces the banks' resilience to potential credit shocks," adds Yin.
Of the RMB10.5 trillion balance of these investments at end-2015, 68% comprised trust and asset management schemes established by non-bank financial institutions, 13% wealth management products, and 19% bonds issued by governments, financial institutions and corporates.
For trust and management schemes -- the bulk of the banks' investments in loans and receivables -- Moody's notes that banks can use these to repackage their existing loans into financial investment products.
At the same time, banks can treat investments with credit enhancement measures from other financial institutions as interbank assets, and assess the credit risk based on the credit profiles of the financial institution counterparties, rather than on those of the ultimate borrowers.
Additionally, the widespread use of credit enhancement increases interconnectedness of financial institutions, and thus the risk that a single institution's failure triggers concerns over broader system stability.
Risks to liquidity positions
Finally, Moody's also sees risks to the banks' liquidity positions -- with them funding their longer-term investments from short-term interbank borrowings -- and interest-rate risk in case of an unexpected liquidity crunch.
Among the 26 banks that have disclosed data on their investments in loans and receivables, Moody's views joint-stock commercial banks and regional banks as most exposed, given their active participation as both investors and originators.
At end-2015, investments in loans and receivables by the nine listed joint-stock commercial banks and the 12 regional listed banks amounted to 19.8% and 19.2% of their total assets respectively, compared to 2.7% for the big five state-owned banks.