China's banks off-balance-sheet loans not scary

The revelation that off-balance sheet loans of China's banks now dwarf those recorded on their balance sheets has raised concerns over the stability of China’s banking sector.

These worries were fuelled recently by a release from Beijing which revealed that off-balance sheet items are now 109 per cent the size of on-balance sheet items.

However, UBS analyst, Jason Bedford says while the sheer scale of off-balance sheet items would suggest that the sector is facing a potentially significant hidden risk, the problem is not as bad as everyone thinks.

Firstly, he thinks this central bank figure could be misinterpreted as it covers non-banks as well as non-risk-bearing off-balance-sheet exposures.

Risk muted

And, as he explains in his latest report on China’s banks, actual off-balance risk is much smaller than off-balance-sheet exposures.

Moreover, his analysis suggests that a significant majority of bank off-balance-sheet exposures bear little or no risk.

“With the exception of bank wealth management products, our breakdown of banks' off-balance-sheet risks indicates a lack of sophistication, complexity or scale.

“While we highlight isolated risk items, such as guarantees and surging asset-backed securities issuance - which could threaten certain individual lenders - in aggregate we believe that the systemic risk posed by bank off-balance sheet activities is still quite muted.”

That said, at the individual bank level the analyst remains concerned, particularly about the joint stocks banks which have the highest ratio of off-balance sheet items to on-balance sheet assets.

ABS fast growing

According to Bedford, ABS has become the most rapidly growing off-balance sheet business.

China's securitisation market has grown around 3,400 per cent since 2013 to reach RMB1.53 trillion of outstanding ABS as of last Monday, 13 November.

But Bedford says this is is not quite the red flag it might appear to be as that figure still only translates into outstanding ABS issuance equivalent to 2 per cent of GDP.

“Further, the growth, particularly in the last two years, has primarily come from non-bank financial institutions and corporates seeking to broaden funding sources beyond bank loans.

In his view, the rapid growth of securitisation has occurred in a highly regulated environment and it would appear to be part and parcel of a broader opening and reform of China’s credit markets beyond bank balance sheets.

“Moreover, interviews with market participants suggest that in many cases the process of securitisation only leads to liability relief, not capital relief, as they retain a significant proportion of the securitised assets on balance sheet post-securitisation while also continuing to put capital against the off-balance-sheet exposures.”

Event unlikely

On Bedford's numbers, bank-issued ABS accounts for less than a quarter of total outstanding issuance.

“We do not view ABS issuance as a risk yet - although we think the rapid change in issuer composition could pave the way for problems down the line.”

The analyst reckons it is “possible” but “very unlikely” that a systemic credit event will occur due to risk exposures off-balance-sheet.

“In the spectrum of risks facing China, banks we regard off-balance sheet risks as relatively minimal and we remain much more concerned with what is on-balance sheet than with what is off-balance sheet.”

“We do remain concerned about the scale of bank off-balance sheet wealth management products which we think still represent the clearest contingent liability risk.

“However, we note that new regulatory pressure in 2017 has significantly curtailed this as a risk overhang.”

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