Chinese banks to be required to hold capital against 'debt receivable' transactions

New rules seen by Bloomberg will prevent banks from using bank-issued wealth management products to invest directly or indirectly in their own bad loans, as well as restrict their ability to move loans off-balance sheet by transferring the rights to receive income under those loans, according to a report. Banks will also be required to hold sufficient capital to cover the risk of default on transferred loans if the underlying loan assets remain on their balance sheets, according to the report.

The new rules are intended to tackle "non-standard and opaque" practices used by mid-tier banks in particular to delay recognising bad loans, Bloomberg said.

Mid- and small-sized banks in China have become "especially active issuers" of wealth management-related shadow banking products in recent months, according to the latest 'China shadow banking monitoring' report by ratings agency Moody's. This is a cause for concern as the "rapid" expansion of these products can be more difficult to monitor, according to the report.

Previous initiatives to reduce the attractiveness of less regulated shadow banking products have successfully slowed the growth of so-called 'core' products, including trust loans, entrusted loans and undiscounted bankers' acceptances, Moody's said. However, this has resulted in activity moving to "less regulated areas", the agency said.

"The growing size of the shadow banking system means that during a disorderly contraction, the banks could face difficulty replacing shadow banking credit, leaving borrowers who rely on such financing at risk of a credit crunch," it said in its report.

Chinese banks are required to hold capital against their credit assets at a level that reflects the risk of that asset. Loans typically carry a 100% risk weighting, so restructuring a loan as an investment can substantially reduce the level of capital that a bank must hold in reserve, according to Bloomberg.