Transparency Fading Away In China

According to a new special report by Fitch Ratings, Chinese banks are moving more and more of its new loans off balance sheet via informal securitization;  re‐packaging of loans into investments products for sale to investors. As a result the credit growth in China is currently much higher than the official figures show, and the transparency in the Chinese financial sector is slowly fading away.

“Adjusted for informal securitization activity, Fitch estimates that the net amount of new CNY loans extended in H110 was closer to CNY 5.9 trillion, or 28% above the official figure of CNY 4.6 trillion.”

Fitch Ratings


Fitch believes the vast majority of these transactions are not publicly disclosed by Chinese banks, and few, if any, traces of the loans remain in financial statements. The growing popularity of this activity is increasingly distorting credit growth figures at an institutional and system level, resulting in pervasive understatement of credit growth and credit exposure.

In the wake of the 2009 credit boom, trends in Chinese bank loan growth have been increasingly under the spotlight. Bank credit rose 33% in 2009 (to 140% of GDP at year‐end), and is on pace for another brisk year in 2010.

With GDP growth now back in double‐digits, Chinese policymakers have been grappling with how to rein in the credit‐fueled stimulus before it leads to overheating, without overshooting.

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“Against this backdrop, the reported deceleration in lending in H110 (Chart 1) has received much attention. The slowdown is cited as evidence that recent administrative tightening is working, and that China’s banks and economy are normalising after the shock of 2008‐09. While the credit environment is less frenzied than in H109, Fitch Ratings cautions that lending has not slowed nearly as much as official data suggests, due to the increasing amount of credit being shifted off of Chinese banks’ balance sheets via informal securitization;  the re‐packaging of loans into investments products for sale to investors,” the rating agency writes in a recent special report on Chinese banks.

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Fitch believes the vast majority of these transactions are not publicly disclosed by Chinese banks, and few, if any, traces of the loans remain in financial statements.

The growing popularity of this activity is increasingly distorting credit growth figures at an institutional and system level, resulting in pervasive understatement of credit growth and credit exposure.

Consequently, Chinese banks’ loan loss reserves and capital are more exposed to credit losses than current data suggests.

“Adjusted for informal securitization activity, Fitch estimates that the net amount of new CNY loans extended in H110 was closer to CNY5.9trn, or 28% above the official figure of CNY4.6trn. While this difference may seem small when compared to the total stock of CNY loans for banks involved in this activity (roughly CNY34trn at end‐June 2010), on a flow basis the volume of credit being shifted off balance sheets in recent times has been large and rising. Activity also is largely concentrated among just a few dozen banks, and institution‐specific exposure is often much higher,” the analysts points out.

According to the report, a key misconception about this activity is that as long as the quality of the investment products’ underlying assets remains strong, there is nothing to worry about.

While asset quality is a key issue, Fitch’s greatest concerns currently centre on liquidity risk, and the growing potential liabilities Chinese banks are taking on in this activity.

Credit‐backed investment products are frequently marketed as substitutes for bank deposits, and investors commonly believe there is an implicit commitment from banks to repay investors upon the products’ maturity.

However, these obligations are not included anywhere in financial statements, and hence represent a hidden call on liquidity.

While China’s large, highly liquid banks may be able to manage these obligations, smaller banks could encounter strains.

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Here’s a copy of the full report.

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