China banks may still have RMB3 trillion in shadow assets by end-2021: S&P

April 27, 2021

HONG KONG -- Some of China's banks are likely to miss their deadlines this year to remove or recognise exposure to "shadow" wealth management products (WMPs),says S&P Global Ratings in a report released today.

This is because a faster dash to the deadline would prove too disruptive, given the knock-on effects to regulatory capital and sector-lending caps, the ratings agency says.

Last year, as the pandemic gripped China's financial system, banks were granted an extension on the deadline to remove or recognise exposure to certain legacy WMPs that are loan-like in nature, and usually held off-balance sheet.

The banks now have until the end of this year to perform this formidable task--but will likely need more time, says the report.

"Regulators are likely to do workarounds with individual banks that are poorly capitalised and can't meet the deadlines, because this exercise can be very capital consuming," says S&P Global Ratings credit analyst, Manqi Xie. "That said, we think most of the legacy WMPs will be addressed in 2021-2022."

While China's wealth management products continue to expand, both off- and on- balance sheet, the problematic WMPs have decreased by 55% to RMB 8.5 trillion (US$1.3 trillion) since the country first announced shadow-banking reforms in April 2018, the report says.

"Some of the loan-like, implicitly-guaranteed products have matured, and are increasingly being replaced by net asset value (NAV) funds. The NAV-style funds are marked to market each day, and considered more transparent. "China's new asset management rules are aimed at reducing hidden financial risks in the system."

S&P estimates that RMB2.5 trillion-RMB 3.5 trillion of banks' non-NAV-type legacy WMPs could remain outstanding by the new deadline of end-2021. If moved onto bank balance sheets, these assets would consume a lot of capital for small and midsized banks.

China's six "megabanks" account for the majority of such legacy instruments; however, they also have larger buffers to absorb the adjustment.

"Banks will use their extended deadline to revamp legacy products, to avoid a huge hit to capital costs and provision charges if these assets are moved onto their balance sheets," Xie notes.

"We project 60%-70% of the legacy-style products [or RMB5 trillion-RMB5.9 trillion] will be revamped by end-2021. This compares with RMB5.7 trillion revamped in 2019, and RMB4.8 trillion last year.

"These products also often carried implicit guarantees, a practice that has had to stop due to the new asset rules, first announced in 2018 with a progressive implementation schedule.

"While regulators might grant additional grace periods on balance-sheet adjustments, less tolerance of implicit guarantees is probable," says Xie. (ATI).