An investor looks at an electronic board showing stock information at a brokerage house in Shanghai on March 16, 2017. (Johannes Eisele/AFP/Getty Images)An investor looks at an electronic board showing stock information at a brokerage house in Shanghai on March 16, 2017. (Johannes Eisele/AFP/Getty Images)

China’s new impetus to rein in its financial sector has been underway for more than three months. The effects are already being felt in the financial markets, impacting short-term borrowing rates and the global commodities market.

In late February, Guo Shuqing was appointed the new chairman of the China Banking Regulatory Commission (CBRC), China’s main banking regulator. Barely a month into his role, Guo issued a flurry of directives described by state-controlled Xinhua as a “strong supervisory storm.”

Guo, 60, is widely seen as a tough regulator willing to challenge financial heavyweights. His predecessor, Shang Fulin, was focused more on maintaining order and stability and did little to assert control over the financial sector, which has grown fat on China’s debt binge in recent years.

The CBRC’s new directives arrive as Chinese Communist Party leader Xi Jinping shifts his anti-corruption focus to the financial sector. Last month, Xiang Junbo, former head of the China Insurance Regulatory Commission, was put under investigation. Sources close to Zhongnanhai—the headquarters of the Communist Party and the State Council—told The Epoch Times last month that there could be further housecleaning within China’s financial industry this year.

Several of the new policy directives from the CBRC aim to deleverage the country’s banking sector. Two main goals are to reduce shadow banking—an umbrella term used to describe various high-yield products sold by banks, insurance companies, and other financial institutions—and to tighten credit.

Shadow Banking Targeted

Shadow banking and other off-balance-sheet credit activities fueled much of China’s recent debt growth, especially by regional and local banks. The biggest type of shadow banking is the sale of wealth management products, which are issued by non-bank entities such as trusts, investment vehicles, or insurance companies but often sold by banks.


Ratio of asset management products to total bank assets by type. (Source: Moody’s Investors Service)

Such products, which circumvent typical lending rules and do not sit on bank balance sheets, have been a critical income source for banks, and often represent the only avenue of financing available for small businesses, local agencies, and ventures that cannot qualify for loans from big state-owned banks.

Off-balance sheet wealth management products totaled 26 trillion yuan ($3.8 trillion) at the end of 2016, an increase of 30 percent from the previous year, according to data from the People’s Bank of China, China’s central bank.

In early February, China unveiled the first coordinated approach to regulate shadow banking. The People’s Bank, the CBRC, and regulators of the insurance and securities industries drafted a joint regulatory framework to tighten supervision of all investment products sold to retail and institutional investors.

Off-balance sheet wealth management products totaled $3.8 trillion at the end of 2016.

This coordination is significant as “previous efforts to regulate the asset management industry have emanated from individual regulators and created opportunities for regulatory arbitrage,” said Moody’s Investors Service, in a Feb. 27 note. In other words, China’s fragmented regulatory framework often allowed banks to sell wealth management products that fall under the jurisdiction of a different regulator—with lower standards—than their underlying assets.

Guo Shuqing, Chairman of the China Banking Regulatory Commission, answers media questions in Beijing on March 8, 2015. (Feng Li/Getty Images)

Guo Shuqing, Chairman of the China Banking Regulatory Commission, answers media questions in Beijing on March 8, 2015. (Feng Li/Getty Images)

A few of the tools introduced by regulators this year include barring the sale of wealth management products derived from non-standard assets other than stocks, bond, and money-market securities and applying a leverage limit across asset classes. One way banks had to boost the interest on wealth management products was to borrow money, and this risky practice will now be curbed.

Short-Term Liquidity Squeeze

Regulators are also targeting the loosely regulated interbank market that allows banks to lend to each other.

The People’s Bank is achieving this by reducing the amount of liquidity available to banks. After skipping open market operations—where the central bank buys or sells government securities—on May 2, it did not renew the 230 billion yuan lending facility, which matured on May 3. Overall, the People’s Bank injected a net 10 billion yuan ($1.5 billion) into the market, a minuscule amount compared to past weeks.

The recent tightening moves have pushed up short-term borrowing rates. The overnight Shanghai Interbank Offered Rate (Shibor) reached 2.83 percent, while the seven-day Shibor reached 2.92 percent on May 5. Those were the highest rates since April 2015.

“We expect liquidity to remain volatile and financial deleveraging to continue, with more ‘mini hikes’ in market rates and tighter new regulations,” wrote Deutsche Bank, in a March note.



Recent Shibor trends reflect tightening of credit (Source: Nomura Securities)

Slowing Economic Growth

The higher funding costs could have real-world economic implications, such as lower availability of credit for businesses and, ultimately, slower GDP growth.

But it’s likely that the official 6.9 percent GDP growth in the first quarter—above most economic forecasts—has given regulators room to curtail credit growth and still attain Beijing’s 2017 annual growth goal of 6.5 percent.

Chinese stocks have languished in recent weeks due to lowered expected future growth. The Shanghai Composite Index trailed other major global indices over the last 30 days, with a decline of 5.4 percent.

More regulatory clampdown may be on the horizon.

The global commodities market—especially sensitive to Chinese demand—has felt the biggest impact. Brent crude was down almost 11 percent over the 30 days ending May 5. Prices of iron ore, copper, and coal futures were also lower over the same period. Iron ore traded on the Dalian Commodity Exchange and hot-rolled coil and steel rebar traded on the Shanghai Futures Exchange plunged by their daily respective maximum allowed rates on May 3.

More regulatory clampdown may be on the horizon. A new rumor is circulating that Guo, the hawkish head of the CBRC, may soon take over as chief of a newly formed super-regulator, the amalgamation of current regulators for the banking, securities and insurance industries, according to the South China Morning Post.

For the Chinese financial industry and global investors, all signs point to further market volatility ahead.

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A driver uses his smartphone to pay the highway toll using Alipay, an app of Alibaba's online payment service, at a toll station on the Hangzhou-Ningbo Expressway in Hangzhou, China.
(STR/AFP/Getty Images)A driver uses his smartphone to pay the highway toll using Alipay, an app of Alibaba's online payment service, at a toll station on the Hangzhou-Ningbo Expressway in Hangzhou, China.
(STR/AFP/Getty Images)

By most accounts, China is the global leader in internet banking and financial technology (fintech) investments.

Fintech’s relevance in China will be on full display this month—during last year’s Chinese New Year holiday week, consumers used Tencent’s WeChat app to send out more than 30 billion digital red envelopes.

Chinese search provider Baidu Inc. in January became the latest technology giant to open a direct bank, joining forces with investment firm China CITIC Bank to form Baixin Bank. Baixin will offer online-only banking and lending services for consumers and small businesses.

With this launch, Baidu joins internet giants Alibaba and Tencent Holdings (together, BAT) in offering direct banking through online banks. Tencent, which runs China’s largest social network WeChat, formed WeBank in 2014. Alibaba introduced two of China’s most successful fintech ventures in MYBank and Ant Financial.

Other Chinese companies are following BAT into the internet banking foray. In late December Xiaomi, one of China’s biggest online smartphone sellers, bought a 30 percent stake in Sichuan XW Bank, a major internet bank in Western China which leverages data to target small-businesses and consumers., a website that specializes in group buying, also formed an internet bank called Jilin Yilian Bank, which received its banking licenses on Dec. 16.

Fintech investments surged to $8.8 billion in the twelve months ended June 30, 2016, according to a joint report by DBS Bank and consultancy firm EY. In early 2016, Ant Financial alone raised $4.5 billion, the largest single private placement in fintech history, putting a $60 billion valuation in the Alibaba-affiliated company. In total, fintech attracted around half of all of Chinese venture capital during 2016.

The major internet banks have performed well financially relative to other startups. In an interview with Chinese media last December, WeBank CEO Gu Min said that financial performance was above expectations and the internet bank was on track to break even or eke out a small profit for 2016.

Two Factors Driving Growth

Fintech’s growth in China is largely an extension of services from BAT, China’s dominant technology giants. There are more than 700 million smartphones in use in China. Those three companies control much of the online and mobile life of Chinese internet users, and converting millions of captive users already in the fold is an evolution of their product strategy.

But the pervasiveness of fintech isn’t just about sheer numbers. In the United States, Facebook and both have millions of captive users, but the companies’ banking and payment services are still in their nascent stages with low adoption rates.

The biggest growth enabler of fintech and internet banking is the traditional banking industry in China. The major banks’ complete neglect of large swaths of consumers, small businesses, and private enterprises has single-handedly spurred recent rise of fintech in China.


(Source: EY and DBS data as of 2014. Illustration by The Epoch Times)

The phenomenon is akin to consumers in parts of Africa quickly moving from having no telephone service to widespread mobile phone adoption, skipping land line service entirely.

China’s big banks generally focus on serving local and regional governments, state-owned enterprises, and large private companies.

Despite being the world’s second-biggest economy, one in five of China’s adults doesn’t have a bank account, according to the DBS and EY report. Bank access for consumers is especially poor outside of major cities. Besides solving the access issue, online banks provide consumers with cheaper and more tailored, customized products.

Small and medium-sized businesses make up another segment overlooked by major banks. While accounting for 60 percent of China’s GDP and 80 percent of urban employment, they make up only 20 to 25 percent of total loans originated by banks.

Despite being the world’s second-biggest economy, one in five of China’s adults doesn’t have a bank account.

This under-served sector has been a major benefactor of internet banks in recent years. During the first eight months after its launch, MYBank said it disbursed over 45 billion yuan ($6 billion) of credit to over 800,000 small to medium-sized businesses.

Large banks also haven’t kept pace in digital infrastructure. The consultancy McKinsey & Co. estimated that major Chinese banks only invested 1 to 3 percent of their pre-tax income to new technology and digital innovations, far below the 17 to 20 percent earmarked for technological innovation at global banks outside of China. The Industrial and Commercial Bank of China, the country’s biggest bank by assets, has recently upgraded its mobile apps and online access, but such services are only available to its corporate clients as of now.

Risky Business

The growth of internet banking in China has also seen its share of problems. Peer-to-peer (P2P) lending is one area within fintech that fizzled in 2016 after explosive initial growth.

Ezubao—at one time China’s biggest P2P lender—turned out to be a Ponzi scheme, defrauding almost $8 billion from 900,000 investors. The company’s collapse set into motion new regulatory rules issued last year to regulate P2P lender activity, including requirements to register with the state, appoint bank custodians, and disclose their use of deposits.

P2P’s rise and fall underscores the risks of fintech’s quick growth in China. Internet banks must receive banking licenses, and fintech solutions provided by major companies such as BAT are often self-regulated and have large internal credit departments.

But other corners of fintech—a broad term that covers everything from mobile payments to online wealth management—are lightly policed and often little understood. Regulators have often been slow to react to market trends and sheer number of new companies formed.

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