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China's banking regulator moves to contain off-balance sheet risk

[BEIJING] China's banking regulator, in a move to rein-in a rapidly growing 'shadow loans' industry, has instructed commercial lenders to properly account for lending products that may appear on their balance sheets as lower-risk investments.

Authorities are tightening scrutiny of the lenders as the growing use of complex financial structures has raised concerns that bad lending and credit risks can be concealed.

The new rules forbid commercial banks from entering into repurchase agreements once a loan's income rights have been transferred, according to a document issued by the China Banking Regulatory Commission (CBRC), a copy of which was seen by Reuters.

Banks also are now required to make adequate provisions for transferred loans where the underlying loan assets remain on their balance sheets.

Individual investors also are forbidden from investing in bad loans through bank-issued wealth management products.

Banks and financial institutions have used the transfer of income rights from credit assets to improve their business, the CBRC document said, but "part of the credit-related transactions are non-standard and opaque" and are not properly accounted for by the banks.

Analysts say the new rules, issued last week, are meant to provide greater transparency and address the rampant growth of investment receivables that are now accumulating on bank balance sheets, particularly among mid-tier lenders.

The size of China's 'shadow loan' book rose by a third to US$1.8 trillion in the first half of 2015, equivalent to 16.5 per cent of all commercial loans in China, according to an analysis by UBS Investment Bank.

The growing use of financial structuring, which involves structures known as Directional Asset Management Plans (DAMPs) or Trust Beneficiary Rights (TBRs), comes at a time when some mid-tier lenders, under pressure from China's slowest economic growth in 25 years, are already delaying the recognition of bad loans.

Banks are required to set aside capital against their credit assets - the riskier the asset, the more capital must be set aside, earning them nothing.

Loans typically carry a 100 per cent risk weighting, but these investment products often carry a quarter of that, so banks can keep less money in reserve and lend more.

Banks must also make provision of at least 2.5 per cent for their loan books as a prudent estimate of potential defaults, while provisions for these products ranged between just 0.02 and 0.35 per cent of the capital value at the main Chinese banks at the end of June, Moody's Investors Service said in a note in December.

REUTERS