Moody's: China's shadow banking activity expands briskly; credit growth outpaces nominal GDP

Moody's Investors Service says that overall shadow banking activity in China (Aa3 negative) expanded briskly during H1 2016.

"We estimate that China's shadow banking sector grew 19% in H1 2016 on an annualized basis to reach RMB58 trillion, equivalent to more than 80% of GDP," says Michael Taylor, a Moody's Managing Director and Chief Credit Officer for Asia Pacific. He notes that the pace of growth slowed compared to the previous year, but that activity continues to be propelled by the issuance of wealth management products (WMPs), which are coming under increasing regulatory scrutiny.

Moody's says that economy-wide leverage continues to increase. In particular, total social financing (TSF), a measure of broad credit, has risen to an estimated 220% of GDP from 206% at end-2015. Credit flows are being sustained by bank lending, especially mortgage loans, and a revival in corporate bond issuance. By contrast, the growth of shadow banking components included in TSF ("core" components) remain subdued. However, Moody's notes that some of the fastest growing shadow banking components are not included in TSF.

Moody's analysis is contained in its latest Quarterly China Shadow Banking Monitor. The Monitor draws on publicly available data sources to provide an overview of trends and developments in this important component of the Chinese financial system.

"Interconnectedness among banks and between banks and the shadow banking system continues to rise," says Stephen Schwartz, a Moody's Senior Vice President. He says that mid- and small-sized banks are especially vulnerable to this trend given their aggressive issuance of WMPs, and investments in non-traditional assets booked under loans and receivables, including WMPs and trust and asset management schemes of non-bank financial institutions.

Moody's points out that an additional risk for mid- and small-sized banks is a high and growing reliance on wholesale funding that exposes them to possible liquidity shocks. Problems that emerge in the shadow banking sector, to which mid- and small-sized banks are particularly exposed, could lead to liquidity shocks that can be transmitted more easily to the rest of the banking system through the interbank market, says Moody's.

The Moody's Quarterly Monitor also notes that E-finance in China is expanding, as it benefits from opportunities afforded by an under-developed consumer banking system. Relative to more advanced financial systems in the West, e-finance players in China have greater opportunities to expand rapidly by providing core financial services and by tapping under-served segments of the market.

The growth of e-finance in China has been promoted by the government's emphasis on internet financial innovation and a hitherto supportive regulatory stance.