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HomeBank CapitalChina Banks May Still Have RMB3 Trillion In Shadow Assets By Year-End...

China Banks May Still Have RMB3 Trillion In Shadow Assets By Year-End Deadline

Last year, as the pandemic gripped China’s financial system, banks were granted an extension on the deadline to remove or recognize exposure to certain legacy wealth management products (WMPs). The banks now have until the end of this year to perform this formidable task–but will likely need more time. S&P Global Ratings believes a faster dash to the deadline would prove too disruptive, given the knock-on effects to regulatory capital and sector-lending caps.

While China’s wealth management products continue to expand, both off and on balance sheet, the problematic WMPs have decreased by 55% to Chinese renminbi (RMB) 8.5 trillion (US$1.3 trillion) since the country first announced shadow-banking reforms in 2018. Some of the loan-like, implicitly guaranteed products have matured, and are increasingly being replaced by net asset value (NAV) funds.

We estimate 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.

Other Than Balance Sheets, Where Will These Assets Go?

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

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Revamping could take the form of repackaging and reselling legacy products into NAV-type products, provided the maturity is matched and investors’ appetites are aligned. In addition, some of these legacy products will naturally mature. With average corporate loan maturities of three to four years in China, we expect natural maturity to play a big role this year. Having said this, there may also be long dated loan-like products and assets backed by additional tier-1 (AT1) capital within the legacy WMPs. These will be harder to resolve because the new rules prohibit complex pooling and maturity mismatch of underlying assets and products.

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For those products that can’t be revamped or matured, banks will mostly likely move them onto their balance sheets, to reflect the risks. This can be capital consuming and we expect individual banks with weaker capitalization to establish a work-out plans with regulatory authorities. While reports say that these workarounds could go as long as 2025, we envisage most will be addressed in 2022. This is considering the additional transition timeframes given to individual banks in past reforms, such as recognition of 90-day overdue loans.

NAV-style products now predominate, however banks have continued to issue or sell…

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