For many years, China has had separate regulators for separate industries. Now, however, Beijing is centralising and coordinating regulation and the resultant tightening of bank lending looks likely to push interest rates higher.

Split supervision led to much regulatory arbitrage in China’s fast-changing financial system. But late last year the regulators’ focus shifted to tackling risks in the banking system, with proposals for tighter controls on wealth-management products.

Then this year the China Banking Regulatory Commission drew up additional rules on how banks manage risk concentration and large-loan risks.

It is concerned with cross-financial business, financial holding companies, and high-risk banking activity. We have also seen the first concerted attempt to set industry-wide standards for wealth management products – a market estimated at RMB60 trillion in 2016 (USD10 trillion).

The new rules will require financial institutions to account separately for each asset-management product, with funding pools that allow short-term funds in longer-term assets or support multiple products.

Inappropriate valuations will be prohibited, and leverage-ratio calculations must reflect all assets with no multiple layers of leverage. Also, ‘fair values’ should reflect returns and risks of the underlying asset. Financial institutions will be penalised for providing guaranteed returns through funding pools, shifting returns between products, or paying investors from the institutions’ own funds.

While a transition period may extend until June 2019, new products issued before then must meet the new regulations.

Already bank-originated issuance of wealth-management products has slowed and greater regulatory scrutiny means that banks will continue to cut back on off-balance-sheet activity in 2018.

The changes will also likely eat into on-balance-sheet credit quotas. Some wealth-management products are not eligible to be put onto balance sheets anyway, so borrowers may have to seek alternative channels.

A general tightening of overall regulations has already restricted lending to property developers and owners and we expect this to continue in 2018.

The combination of these dynamics will continue to put upward pressure on interest rates in the general loan market this year. Higher short-term rates have increased banks’ funding costs, which should make them more profit conscious when making lending decisions.

The average interest rate on general loans at the start of this year already exceeded the policy rate by 1 percentage point and we expect the gap to grow even larger in 2018.

Monetary conditions tightened during 2017 but the rise in short-term interest rates transmitted to longer-term rates much faster than in previous economic cycles. Lending growth has eased marginally with the exchange rate gradually easing.

The baton for deleveraging or for broader financial regulatory reform has already been passed onto the regulator, with a national Financial Stability Committee now centralising and coordinating policies. More centralised policy-making and a clearer separation between monetary and regulatory policies should give China’s central bank more reason to maintain its current monetary policy stance in 2018.

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Growth through spending
Tax cuts and budget deals will mean interest rates rise higher and quicker.
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