An Inflection Point in China's Systemic Risk

Chinese banks have reached an inflection point in the accumulation of investment receivables assets, a source of systemic financial risk. The consensus viewpoint claims that for years banks have repackaged non-performing and risky assets into so called “trust beneficiary receipts” – the largest component of the investment receivables account – to avoid taking losses on NPLs and reduce loss provision costs. To catch up to speed on this issue, you can read reporting from the WSJ, FT, and Bloomberg.

Industrial Bank, the largest holder of investment receivables, exemplifies how loss provision requirements incentivize banks to repackage assets like this. The most recent annual report disclosed that they set aside only 0.5% in loss provisions for investment receivables compared with 2.7% for loans.

China’s joint-stock and regional banks (SMB), constrained by relatively smaller deposit bases and a regulation on the ratio of loans to deposits, lustily exploit this part of the balance sheet. However, their accumulation of such assets has finally reached an inflection point – SMB reduced exposure for the first time in five years.

Totaling over 15% of all SMB assets, investment receivables still pose systemic risk for China’s banking system. Additionally, given the incentives of regulated institutions everywhere, it is likely that risks have simply begun to migrate to new and more opaque parts of the balance sheet. As China watchers, we should prepare for yet another game of financial risk whack-a-mole.