Call for Closer Scrutiny of Shadow Banking

The prestigious China Academy of Social Sciences has called for closer supervision of so-called shadow banking, which has grown to more than 20.5 trillion yuan (US$3.3 trillion) in total assets - roughly 16 percent of the aggregate of the entire banking system.

In its latest annual financial market report, the academy said that by operating outside the official banking system, shadow banking has helped enhance the efficient allocation of deposits and applied innovative financial methods to promote the reform of China's interest rate liberalization. But certain problems have been exposed in terms of the development of China's shadow banking system.

"The shadow banking sector in China, which is vaguely defined but mainly includes trust companies and the investment in wealth management products using clients' capital, has developed rapidly since 2010," said Rui Meng, a professor of finance and accounting, at the China Europe International Business School in Shanghai.

The problems caused by shadow banks include liquidity risks caused by maturity mismatches of products, which will increase if the market expands and have a negative effect on the financial system eventually.

Therefore, the related department should release a series of measures to supervise the shadow banking system in China, the report said.

"China's shadow banking sector has become a potential source of systemic financial risk over recent years while many assets underlying the products are dependent on certain risky projects. This may mean it will be impossible to generate sufficient cash flow to meet repayment obligations," said Jimmy Leung, the banking and capital markets leading partner of PricewaterhouseCooper China.

The supervision will be focused on enhancing information disclosure of products of shadow banks by providing a more transparent introduction to investors so they know where those funds will be invested and the potential risks involved, the report said.

The goal is to prevent systemic risk in the financial world and have new supervision to fit the trend toward mixed operations in the financial industry.

"Supervision to regulate the shadow banking sector is essential. It will ensure the growth of the banking industry and improve the development of the shadow banking sector with healthy competition and more diverse sources of capital," said Leung.

Leung added interest rate liberalization was a method to fit the development of the shadow banking sector, which could be further monitored and regulated.

Certain measures were issued recently to regulate the shadow banking system on a continuous basis.

A notice was issued by the China Banking Regulatory Commission earlier this year to regulate the investment services of wealth management products operated by commercial banks.

"The regulation released in March has managed to regulate banks selling wealth management products under controllable risk conditions and under regulated supervision. Meanwhile most trust companies and banks have self-protection systems to avoid risk," said Rui.

In addition, the report also said supervision over private financing activities should be more regulated to lower the risks for private loan-lending companies to issue loans.

Take the example of the small loan companies in Wenzhou. The city is currently undergoing financial reform to regulate private lending activities, while more risk-control policies have been imposed.

"We've been required to have more risk-control measures to prevent the occurrence of large amounts of unpaid debts from a single borrower by imposing greater restrictions on enterprises applying for loans," said Weng Yifeng, chairman of Ruian Huafeng Small Loan Co Ltd in Wenzhou, Zhejiang Province.