China took aggressive steps on Wednesday, 24 August, to head off signs of growing risks in its financial and banking system, unveiling detailed rules to curb an unruly peer-to-peer ("P2P") lending sector and intervening in its money markets.
In the past year, Chinese policymakers have been moving levers to try to keep credit growing at a reasonable pace to underpin the economy, while addressing vulnerable aspects of the financial and banking system.
But sharply increasing debt levels have raised alarm bells, most lately from the International Monetary Fund, about the health of the financial system. The country’s stock market crash last year is still fresh in investors' minds.
This year, officials have expressed concern about the unravelling of Chinese peer-to-peer ("P2P") online lending platforms that they had once hoped would provide a new channel of funding to spur the economy’s growth.
On Wednesday, the banking regulator and other government entities issued measures to curb a sector that has produced a raft of scandals. Almost half of the 4,000-odd lending platforms are "problematic", the China Banking Regulatory Commission warned.
The measures will probably leave about 200 to 300 P2P platforms by this time next year, said James Zheng, chief financial officer of Lufax, the top lending platform in China.
"That's okay because they're cracking down on all the bad guys," he said at a conference in Hong Kong. "What doesn't kill will make you stronger. That's the case for us."
The $93 billion P2P lending sector has been a source of funds for individuals and small businesses overlooked by the country's traditional financial services that prefer big borrowers with better credit history and collateral and links to the government.
But Beijing's hands-off approach to promote the sector as a form of financial innovation led to a rash of high-profile P2P scandals and frauds.
Ezubao, once China's biggest P2P lending platform, folded earlier this year after it turned out to be a Ponzi scheme that solicited 50 billion yuan in less than two years from more than 900,000 retail investors through savvy marketing. Retail investors have been unable to get their money back.
Under the new rules, P2P firms cannot sell wealth management products or issue asset-backed securities. They must use third-party banks as custodians of investor funds and will not be permitted to take deposits.
The banking regulator also set a ceiling for borrowers on P2P platforms.
Outstanding loans issued on P2P platforms had reached 621.3 billion yuan, data from the regulator showed.
Money Market Squeeze
China's overall debt has risen rapidly since the global financial crisis. Outstanding debt was $26.56 trillion, or 255 percent of gross domestic product at the end of 2015, according to the Bank for International Settlements.
While debt has played a key role in stimulating and shoring up economic growth, policymakers in China are not unaware of the risks.
The central bank is holding off on cutting bank reserve requirements or interest rates for fear such moves could fuel more cheaper credit, put downward pressure on the yuan and fuel outflows from its mountain of more than $3 trillion in foreign reserves.
That view was solidified in financial markets this week, prompting a sharp selloff in bond futures following a summer rally.
In turn, that appears to have worried the central bank that too many small banks had jumped on the bond rally using short-term borrowing to fund purchases, traders said.
So on Wednesday, it injected cash into money markets through 14-day reverse repurchases agreements for the first time in six months to show its concern about the rising leverage.
For most of 2016, the People’s Bank of China ("PBOC"), the central bank, had used the lower interest seven-day rate, with cash injections nearly every day.
"The PBOC appears to be signalling to banks to move away from a reliance on short-term liquidity and head towards more longer-term liquidity," Jonas Short, head of NSBO Policy Research in Beijing, said in a note.
He said if short-term interest rates continue to tighten, it could hurt China’s small banks.
"There may be potential for a liquidity squeeze for small banks on the horizon," he said.
The central bank’s injection of money into the financial system using 14-day reverse repos was also taken as a signal by financial markets that further cuts to bank required reserve ratios were unlikely.