China's property sector still poses major risks to shadow bank lending in the country, although its share of the loans is declining, a new report finds.
Trust lending to the property sector has fallen sharply in three years, but real estate trusts accounted for around 80% of defaulted trust schemes over the first seven months of 2022, Moody's Investors Service says in the latest edition of its China Shadow Banking Monitor.
"Furthermore, contagion risk from small banks remains because they are more exposed to the distressed property sector than large banks and significantly fund non-bank financial institutions," says Lillian Li, vice-president and senior credit officer at Moody’s.
Lower market confidence in smaller banks (city and rural commercial banks) has widened the spreads of their negotiable certificates of deposit (NCDs) compared with NCDs from mid-size banks (joint-stock banks). However, the People's Bank of China's measures to improve liquidity conditions have reduced overall issuing rates of NCDs.
The shadow banking sector is now contracting at a slower rate than before the pandemic. Government measures to shrink and de-risk the sector have cut shadow banking assets by 1.41 trillion yuan (US$196 billion) in the first half of 2022 to 55.6 trillion yuan.
Still, regulators will remain focused on dismantling the interconnectedness between shadow banking and the highly leveraged property sector, and shadow banking and the wealth management channel businesses, the rating agency says.
"However, we now expect the size of the shadow banking sector to stabilize or even expand slightly as the government pivots to supporting economic growth,” Li notes. “Over the next few months, credit growth is likely to rise moderately from weak levels because of monetary policy easing."
Currently, credit demand remains weak amid increased economic uncertainty, and further monetary easing may not significantly increase credit flows.
Despite multiple cuts in policy rates and banks' reserve requirement ratio, overall credit flows such as formal bank loans and direct financing have yet to show any increase in 2022, the report says.
