CHINA HOT TOPICS CHINAS FINANCIAL LEVERAGE: AN

ENDLESS CAT AND MOUSE GAME

05 September 2017
CONTINUES TO BENEFIT LARGE BANKS

When one door closes, another one opens up. As deleverage

becomes a higher level objective (but sometimes conflicting) to the
Chinese leadership, banks now face more restrictions from regulators.
In any event, this is not the first time they find themselves in the
NCDs Held by Investors (%)
Other Entity Non Bank FI Commercial Bank
regulatory whirlpool. From the usage of repo agreements to wealth
management products (WMPs), and most recently negotiable
100
80 39 42 46 39 44 45 48
60 11 8
10 9 13 14
40 13
51 47 45 53 43
20 41 38
0
Q1 Q2 Q3 Q4 Q1 Q2 July
16 17
Source: Natixis, CEIC

NCD (% of Total Liabilities) certificate of deposits (NCDs), banks have been very creative in
playing the cat and mouse game in front of evolving regulations.
14
12 After the PBoC limited the use of WMPs, there are now also more
10 CCB regulations targeted at NCDs, which are short-term, non-collateralized
8 JSCB paper with an even higher funding cost than the SHIBOR. This has led
All to a fall in issuance, but has grown again since June 2017. The
6
RCB
4 underlying reasons could probably be a lack of other options and the
SOCB
2 regulations are not as tight as they may appear on the surface. In fact,
0 the PBoCs pressure affects banks very differently. It penalizes banks
15 16 17 short of liquidity and benefits those long of liquidity. This simply means
Source: Natixis, WIND
that Chinas five largest commercial banks (all state-owned) are the
winners while the others are the losers.
NCDs Held by Investors (%)
As liquidity is increasingly expensive, liquidity scarce banks have also
Other Entity Non Bank FI Commercial Bank developed new ways to bypass regulations through money market
100 funds (MMFs), which have reached 5.86 RMB trillion in a very short
80 39 42 46 39 44 45 48 period of time. The quick pace of expansion may pose extra liquidity
60 11 8 risks especially when three-quarter of the assets have a maturity less
10 9 13 14
40 13 than 90 days.
51 47 45 53 43
20 41 38
Beyond the probably unintended push for financial innovation, the
0
Q1 Q2 Q3 Q4 Q1 Q2 July PBoCs regulatory move is also pushing further the duality of Chinas
banking system. When small banks are struggling for liquidity, large
16 17
Source: Natixis, CEIC
banks stand to benefit from the regulatory crackdown. The latest 2017
Q2 results have confirmed our expectations that large banks can gain
from regulatory arbitrage and risks are rising for smaller banks. In
other words, the improvement in bank results is not only due to better
economic conditions but also to regulatory arbitrage.

Alicia Garcia Herrero

Tel. +852 3900 8680
alicia.garciaherrero@ap.natixis.com

With contribution from

Gary Ng
Tel. +852 3915 1242
gary.ng-ext@ap.natixis.com

www.research.natixis.com
CORPORATE & INVESTMENT BANKING
INVESTMENT SOLUTIONS & INSURANCE
SPECIALIZED FINANCIAL SERVICES Distribution of this report in the United States. See important disclosures at the end of this report.
 CHINA HOT TOPICS

Time to be creative again

When one door closes, another one opens up. As deleverage becomes a higher level objective (but sometimes
conflicting) to the Chinese leadership, banks now face more restrictions from regulators. In any event, this is not the
first time they find themselves in the regulatory whirlpool. From the usage of repo agreements to wealth management
products (WMPs), and most recently negotiable certificate of deposits (NCDs), banks have been very creative in
playing the cat and mouse game in front of evolving regulations.

Chart 1 Chart 2
Yields are increasing (%) Wealth Management Products
SHIBOR O/N NCD 6M Govt 10Yr Yield RMB tr %YoY (rhs)
5 5 35 60
30 50
4 4 25
40
20
3 3 30
15
20
2 2 10
5 10

1 1 0 0
15 16 17 15 16 17
Source: Natixis, WIND Source: Natixis, CBRC, WIND

Flourishing financial innovation has helped Chinas leverage process to continue unabated. As we argue in a recent
note, the deleveraging process has hardly begun. In contrast, liquidity seems to be very increasing scarce, which
keeps on lifting the cost of funding. In fact, overnight SHIBOR is at record high since the difficult events in 2015, very
close to 3% (Chart 1).

One of the key reasons for the liquidity shortage is related to tighter regulatory control from the People's Bank of
China (PBoC), in particular stricter Macro Prudential Assessment (MPA). This has hampered the use of WMPs to fund
banks asset growth. They have already shrunk by 1.6 RMB trillion to 28.4 RMB trillion in May 2017 (Chart 2).

NCDs remain attractive to banks craving for liquidity

WMPs are not alone in the regulatory crackdown. There are now more regulations targeted at NCDs, which are short-
term, non-collateralized paper with an even higher funding cost than the SHIBOR (Chart 1).

The recent move to include NCDs in the MPA has led

Chart 3
to a fall in issuance, but has grown again since June NCD Issuance (RMB bn)
2017 (Chart 3). The underlying reasons could probably
be a lack of other options and the regulations are not as 2,000
tight as they may appear on the surface
1,500 SOCB
The impact of the new rule on banning the issuance of
RCB
NCDs with maturity of more than 1 year remains
1,000
limited. This is because most of the issuance so far is JSCB
shorter term. In addition, the inclusion of NCDs to the CCB
interbank liabilities celling (33% of total liabilities) under 500
the assessment is likely to create more pressure on
banks. However, banks could decide to neglect the 0
component as interbank liabilities only forms a relatively 15 16 17
small score under the asset liability management Source: Natixis, WIND
criteria (25 out of 100, 60 as the passing score).

Due to different exposure on shadow banking and liquidity management, the PBoCs pressure affects banks very
differently. It penalizes banks short of liquidity and benefits those long of liquidity. This simply means that Chinas five
largest commercial banks (all state-owned) are the winners while the others are the losers.

2
 CHINA HOT TOPICS

Money market funds are the new intermediaries

Chart 4
As liquidity is increasingly expensive, liquidity scarce Composition of NCDs Held by Investors (%)
banks have also developed new ways to bypass Other Entity Non Bank FI Commercial Bank
regulations through money market funds (MMFs), as 100
shown by the proportion of NCDs holding by special
80 39 42 46 39 44 45
purpose vehicles (Chart 4). 48
60 11 8
10 9 13
While banks are pressured to hold less interbank 14 13
40
assets, money market funds (MMFs) are relatively more
51 47 45 53
flexible. MMFs act as intermediaries to hold NCDs, and 20 43 41 38
hence repackage products for retail and institutional 0
investors (Chart 5). The investors could also include Q1 Q2 Q3 Q4 Q1 Q2 July
banks with excess liquidity, indicating this is a way to
16 17
add leverage within the financial sector.
Source: Natixis, CEIC

Chart 5
NCDs and Money Market Funds
NCDs Products

Banks Money Market Funds Investors

Liquidity Investment

Investors could also be banks

Source: Natixis

In fact, MMFs have seen a massive increase in July 2017, rising 15% to 5.86 RMB trillion in a single month (Chart 6).
This is equivalent to 92% of the total increase in the first half this year. The quick pace of expansion may pose extra
liquidity risks especially when three-quarter of the assets have a maturity less than 90 days (Chart 7).

Chart 6 Chart 7
Money Market Fund (RMB bn) MMF Weighted Average Maturity (2017 Q2, Days)
MoM Change (rhs) Fund Size
6,000 1,500
5,500 >120
17% 1 - 30
5,000 1,000 26%
4,500 90 - 120
4,000 500 8%
3,500
30 - 60
3,000 0
60 - 90 15%
2,500
34%
2,000 -500
Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17
Source: Natixis, AMAC Source: Natixis, WIND

Large banks are clear winners

Beyond the probably unintended push for financial innovation, the PBoCs regulatory move is also pushing further
the duality of Chinas banking system. When small banks are struggling for liquidity, large banks stand to benefit from
the regulatory crackdown. The latest 2017 Q2 results have confirmed our expectations that large banks can gain from
regulatory arbitrage and risks are rising for smaller banks.

SOCBs have seen improved net interest margin, but generally not for smaller banks (Chart 8). While large banks
manage to maintain a stable return on assets, the ratio has fallen for the others (Chart 9). This is due to the funding
cost of shadow banking instruments have continued to increase. JSCB plays a very active role in WMPs issuance
(Chart 10). In addition, CCB and JSCB increasingly rely on NCDs, with the former reaching 13.5% of the total
liabilities (Chart 11). In other words, the improvement in bank results is not only due to better economic conditions but
also to regulatory arbitrage.

3
 CHINA HOT TOPICS

Chart 8 Chart 9
Net Interest Margin (%) Return on Asset (%)

17 Q1 17 Q2 17 Q1 17 Q2
3.0 1.4

2.5 1.2
1.0
2.0
0.8
1.5
0.6
1.0
0.4
0.5 0.2
0.0 0.0
SOCB JSCB CCB RCB SOCB JSCB CCB RCB
Source: Natixis, WIND Source: Natixis, WIND

Chart 10 Chart 11
Outstanding Wealth Management Products Outstanding Negotiable Certificate of Deposits
(RMB tr) (% of Total Liabilities)
30 14 14

25 12 12
Others
10 10 CCB
20 RCB
8 8 JSCB
15 CCB All
6 6
10 SOCB RCB
4 4
SOCB
5 JSCB
2 2
0 0 0
2015 2016 15 16 17
Source: Natixis, CEIC Source: Natixis, WIND

Related research
Is China really deleveraging? Not yet (30 Aug 2017)
Liquidity arbitrage in Chinas banking sector: Another bias towards large state-owned banks (13 Apr 2017)
Chinese banks liquidity problem: Regulation and lack of collateral as key culprits (31 Mar 2017)
China Banks in 2017: No rebound in sight, rising risks for smaller banks (17 Jan 2017)
Key risk to Chinas shadow banking in 2017: Banks and WMPs (5 Jan 2017)

4
 CHINA HOT TOPICS

Head of Global Markets Research

Denis Prouteau
+33 1 58 55 32 51
denis.prouteau@natixis.com

Asia Pacific Research

Chief Economist
Alicia Garcia Herrero
+852 3900 8680
alicia.garciaherrero@ap.natixis.com

Emerging Asia Greater China Japan, Pacific

Economist Economist Economist
Trinh Nguyen Jianwei Xu Kohei Iwahara
+852 3900 8726 Tel. +852 3900 8034 +852 3900 8564
trinh.nguyen@ap.natixis.com jianwei.xu@ap.natixis.com kohei.iwahara@ap.natixis.com

5
 CHINA HOT TOPICS

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