China Tells Banks to Limit Any Risk From Entrusted Loans

(Bloomberg) -- China took another step to clamp down on leverage in the financial system, ordering banks to ensure they aren't exposed to risks from their entrusted loan business.

Banks can only act as intermediaries when arranging entrusted loans, and must not provide guarantees or get involved in decision-making, according to new rules posted in a statement on the China Banking Regulatory Commission's website over the weekend.

The CBRC's measure is the latest attempt by China to curb the threat that excessive leverage in the financial system poses to the nation's economy. President Xi Jinping and his senior economic officials have vowed to make controlling financial risks a top priority, a pledge renewed at the Communist Party's twice-a-decade leadership congress in October.

The entrusted loan business, which normally involves companies providing finance to each other with banks acting as intermediaries, has seen “certain potential risk hazards” due to rapid growth and a lack of regulation, according to the CBRC statement. Entrusted loans can't be used for investments in bonds, derivatives, asset management products or equities, the CBRC said, adding that banks cannot put their own money or funds they manage into such loans.

Risky Areas

Entrusted loans contain higher credit risk because they are less regulated and often extended to risky areas, such as local government financing vehicles and property developers, according to Terry Sun, an analyst at RHB Securities Hong Kong Ltd. Higher yields offered by entrusted loans have prompted some non-financial corporates to put their spare cash in such offerings, he said.

“This would magnify system leverage and push up funding costs for the real economy,” Sun wrote in a note. The CBRC's measure should therefore “reduce leverage and the circulation of capital within the financial system.”

The new CBRC rules will have limited impact on Chinese banks' revenue because the entrusted loan business was already on the decline, following rapid growth in the three years to 2016, China International Capital Corp. analysts including Victor Wang said in a note. Investments through entrusted loans reached 7.4 trillion yuan ($1.14 trillion) at end 2016, the CICC analysts said.

--With assistance from Jun Luo

To contact the reporter on this story: Alfred Liu in Hong Kong at aliu226@bloomberg.net.

To contact the editors responsible for this story: Marcus Wright at mwright115@bloomberg.net, Colin Keatinge, Sree Vidya Bhaktavatsalam

©2018 Bloomberg L.P.