Moody’s Investor Service says that the Chinese banks’ rising investments in loans and receivables in recent years has raised system risks in the long-term.
In a Wednesday report, the research house shares that its recent data from the 26 mainland Chinese listed banks reflects a jump in such investments from RMB2.5 trillion ($509 billion) to RMB10.5 trillion, from end-2012 to end-2015 respectively.
68% of the RMB10.5 trillion comprised trust and asset management schemes established by non-bank financial institutions, which forms the bulk of the banks’ investments in loans and receivables.
It is notable that joint-stock commercial banks and regional banks have contributed most to the increase of investments in loans and receivables. Such banks have also been identified by Moody’s as the most exposed to system risks resulting from such investments, given their active participation as both investors and originators.
Moody’s assistant vice president and analyst David Yin acknowledges that investments in loans and receivables, due to their high yields and low provisioning costs, have enabled continued earnings growth for the banks in the short term.
Despite this, he raises three main credit concerns that he believes will result from the surge of investments in these asset classes. These involve increasing:
1. Asset risks
“The use of ‘pass through’ channels and credit enhancement obscures the true extent of the banks’ exposure to the ultimate borrowers, while lower provisioning and capital requirements reduces the banks’ resilience to potential credit shocks,” says Yin. This is especially so for trust and management schemes, the bulk of the banks’ investments in loans and receivables, as banks can use these to repackage their existing loans into financial investment products such that their deposit bases are overstated.
2. Credit risks
The widespread use of credit enhancement, although supportive of individual transactions, will cause the interconnectedness of financial institutions to also rise. Yin warns that should even a single institution in this network fail, broader system stability concerns could be triggered. Such a reaction will lengthen financial intermediation chains and likely result in the potential multiplication of credit risk.
3. Material liquidity and interest rate risks
As banks fund longer-term investments with shorter interbank borrowings, such a process will cause liquidity risk stemming from discrepancies in the maturity of their investments in loans and receivables, according to Yin.
Many of these investments are “loan-like” in terms of liquidity profile although they are not recognised as loans, meaning that the banks’ loan-to-deposit ratios could be understated.
“Bank disclosures suggest that close to half of these investments have tenors of one year or longer, and secondary market liquidity for these investments is lacking,” he elaborates. “This exposes the banks to potential asset and liability mismatches and leaves them vulnerable to an unexpected market liquidity crunch.”
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In a Wednesday report, the research house shares that its recent data from the 26 mainland Chinese listed banks reflects a jump in such investments from RMB2.5 trillion ($509 billion) to RMB10.5 trillion, from end-2012 to end-2015 respectively.
68% of the RMB10.5 trillion comprised trust and asset management schemes established by non-bank financial institutions, which forms the bulk of the banks’ investments in loans and receivables.
It is notable that joint-stock commercial banks and regional banks have contributed most to the increase of investments in loans and receivables. Such banks have also been identified by Moody’s as the most exposed to system risks resulting from such investments, given their active participation as both investors and originators.
Moody’s assistant vice president and analyst David Yin acknowledges that investments in loans and receivables, due to their high yields and low provisioning costs, have enabled continued earnings growth for the banks in the short term.
Despite this, he raises three main credit concerns that he believes will result from the surge of investments in these asset classes. These involve increasing:
1. Asset risks
“The use of ‘pass through’ channels and credit enhancement obscures the true extent of the banks’ exposure to the ultimate borrowers, while lower provisioning and capital requirements reduces the banks’ resilience to potential credit shocks,” says Yin. This is especially so for trust and management schemes, the bulk of the banks’ investments in loans and receivables, as banks can use these to repackage their existing loans into financial investment products such that their deposit bases are overstated.
2. Credit risks
The widespread use of credit enhancement, although supportive of individual transactions, will cause the interconnectedness of financial institutions to also rise. Yin warns that should even a single institution in this network fail, broader system stability concerns could be triggered. Such a reaction will lengthen financial intermediation chains and likely result in the potential multiplication of credit risk.
3. Material liquidity and interest rate risks
As banks fund longer-term investments with shorter interbank borrowings, such a process will cause liquidity risk stemming from discrepancies in the maturity of their investments in loans and receivables, according to Yin.
Many of these investments are “loan-like” in terms of liquidity profile although they are not recognised as loans, meaning that the banks’ loan-to-deposit ratios could be understated.
“Bank disclosures suggest that close to half of these investments have tenors of one year or longer, and secondary market liquidity for these investments is lacking,” he elaborates. “This exposes the banks to potential asset and liability mismatches and leaves them vulnerable to an unexpected market liquidity crunch.”
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