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Deutsche Bank Markets Research
Asia
Hong Kong
Banking / Finance
Banks
Industry
Chinese banks
Date
20 November 2017
Breaking News
Asset Management Guideline – Reshaping China’s shadow banking
Long-awaited asset management guidance, a long-term positive for China
________________________________________________________________________________________________________________ Deutsche Bank AG/Hong Kong
Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 083/04/2017. THE CONTENT MAY NOT BE DISTRIBUTED IN THE PEOPLE’S REPUBLIC OF CHINA (“THE PRC”) (EXCEPT IN COMPLIANCE WITH THE APPLICABLE LAWS AND REGULATIONS OF PRC), EXCLUDING SPECIAL ADMINISTRATIVE REGIONS OF HONG KONG AND MACAU.
Hans Fan, CFA
Research Analyst
(+852 ) 2203 6353
Jacky Zuo
Research Analyst
(+852 ) 2203 6255
Edward Du
Research Associate
(+852 ) 2203 6185
Top picks
Bank of China (3988.HK),HKD3.78 Buy
Agri. Bank of China (1288.HK),HKD3.62 Buy
China Construction Bank (0939.HK),HKD6.81
Buy
Source: Deutsche Bank
Companies Featured
ICBC (1398.HK),HKD6.19 Buy
China Construction Bank (0939.HK),HKD6.81
Buy
Agri. Bank of China (1288.HK),HKD3.62 Buy
Bank of China (3988.HK),HKD3.78 Buy
Bank of Communications (3328.HK),HKD5.82
Buy
China Merchants Bank (3968.HK),HKD31.30
Hold
China CITIC Bank (0998.HK),HKD5.02 Hold
China Minsheng Bank (1988.HK),HKD7.51 Hold
CEB (6818.HK),HKD3.66 Sell
Chongqing Rural Bank (3618.HK),HKD5.31 Hold
Huishang Bank (3698.HK),HKD3.95 Sell
Bank of Chongqing (1963.HK),HKD6.16 Sell
Shanghai Pudong Bank (600000.SS),CNY12.78
Hold
Ping An Bank (000001.SZ),CNY13.18 Hold
Industrial Bank (601166.SS),CNY17.35 Sell
Bank of Beijing (601169.SS),CNY7.44 Buy
Bank of Nanjing (601009.SS),CNY8.13 Sell
Bank of Ningbo (002142.SZ),CNY17.90 Sell
Source: Deutsche Bank
We value Chinese banks using a three-
stage GGM (PV= (ROE-g)/(COE-g)), with
target prices based on 2017E book
values. Downside risks: large-scale DES
on government intervention, over-
tightening and property price correction.
Upside risks: SOE reforms and removal
or softening of GDP targeting.
China released the consultative draft for The Guideline on Asset Management Businesses. Targeting the fast-growing asset management sector, an essential part of shadow banking, it proposes capping leverage, reducing duration mismatch, cutting down SPV layers and removing implicit guarantees. We view it as a vital step in continuing financial deleveraging. Near term, we see limited impact on liquidity, as the regulations are largely expected and there is a 19m grace period. But, we see it as a L/T positive, as it raises transparency and caps the growth in shadow banking. We expect divergent impact on banks, as it favours big banks while adding pressure to smaller ones.
How big is the asset management sector and what are the key risks? China’s asset management sector includes asset management plans issued by different financial institutions. According to the PBOC, total AUM amounted to Rmb102tr as of 2016 (or 137% of GDP), or 50% CAGR since 2011. We estimate the credit channeled through the asset management sector has contributed 80% of shadow banking credit, or c.18% of system credit. While it supported economic growth, the proliferation of the asset management sector does come at a cost, with key risks including: 1) liquidity risks due to duration mismatch; 2) contagion risks given multiple layers of SPVs and rising leverage; 3) under-capitalization and under-provisioning; and 4) implicit guarantees, which lift the actual risk free rate and deepen moral hazard issues. What are the proposed measures to reduce risks? This new regulation standardizes product classifications regardless of regulatory regimes, splitting asset management products into publicly-raised and privately-raised ones. Next, based on the new product classification, the regulation stipulates: 1) stop asset-pool operation and lengthen duration of funding; 2) to cap leverage in both borrowed money and product tranches; 3) to cap layers of SPVs; 4) to limit investment in non-standard credit assets by publicly-raised funds; 5) to strengthen capital and provision charge requirement; 6) to encourage NAV-type products and prohibit implicit guarantees. This is a high-level guideline; we expect more detailed regulations. What are the implications for the entire financial system? This is the first regulation targeting the entire asset management sector and is issued post establishment of the Financial Stability Development Committee. So, it suggests that regulatory coordination has been strengthened, which should help curb the regulatory arbitrage of shadow banking by closing loopholes and reducing regulatory competition. This may lead to slower shadow banking growth and reduce the murkiness. Also, it should drive down banks’ WMP yield, which help lower the actual risk free rate. This is why we see it as a long-term positive. In the near/medium term, we expect: 1) credit growth to moderate, slowing system leverage build-up; 2) banks’ WMP and NBFIs’ AUM to slow or shrink; and 3) banks’ asset growth to slow. What are the implications for individual banks? With elevated shadow banking exposure and lower degree of compliance, smaller banks are likely to face persistent capital and earnings risks. As WMP yield might fall, it would become harder for them to grow deposits thus adding funding pressure. In contrast, big banks should benefit from better loan demand and stable deposit growth. We prefer big banks over the smaller ones.
Distributed on: 19/11/2017 20:45:33 GMT
0bed7b6cf11c
20 November 2017
Banks
Chinese banks
Page 2 Deutsche Bank AG/Hong Kong
Asset Management Guideline – Reshaping China’s shadow banking
Overview of China’s asset management sector
After market close on 17 November 2017, China’s five regulators, including
PBOC, CBRC, CIRC, CSRC and SAFE, jointly released the long-awaited
consultative draft for The Guideline on Regulating Asset Management
Businesses of Financial Institutions. It aims to standardize the regulatory
requirements across various asset management products, to contain financial
risks and to direct lending to support the real economy. We believe this
regulation is going to reshape China’s shadow banking
How big is the asset management sector?
According to PBOC, China’s asset management industry includes: (1) banks’
on & off balance sheet wealth management products; (2) brokers’ asset
management schemes; (3) trust investment schemes; (4) public mutual funds;
(5) fund and fund subsidiaries’ investment schemes; (6) private funds; and (7)
insurance investment funds. What differentiates China’s asset management
sector from others is that it is an essential part of shadow banking in China.
Total AUM of asset management industry came to Rmb102tr as of end-2016
(or 137% of GDP), or Rmb60-70tr if stripping out the overlap among these
subsectors, e.g. banks’ entrusted some of their assets from WMP to brokers’
investment schemes to invest in some other non-standard assets. We
calculated total AUM of asset management industry posted a CAGR of 50% in
2011-2016, as shown in Figure 1. This is much faster than total system loan
CAGR of 14% in the same period. Among those assets, banks’ WMPs made up
a meaningful weighting of 27% of total AUM in 1H17, followed by trust
investment schemes (18%) and brokers’ asset management schemes (17%).
Figure 1: Asset management industry AUM CAGR came to 50% in 2011-16
4.6
7.1 10.2 15.0
23.5 29.0 28.4
0.3 1.9
5.2
7.9
11.9
17.6 18.1
4.8 7.0
10.3
13.0
14.7
17.5 19.6
1.6 2.3
3.2
4.5
8.4
9.2 10.1
1.2 2.1
3.5
5.9
12.60
16.9 14.9
0.6
0.8
0.9
1.2
1.4
1.7 1.9
0.2
0.4 1.0
2.1
5.1
10.2 9.5
-
20.0
40.0
60.0
80.0
100.0
120.0
2011 2012 2013 2014 2015 2016 1H17
Private funds
Insurance Investment Fund
Fund and fund subsidiaries'
investment schemes
Public mutual fund
Trust investment schemes
Brokers asset management
schemes
Banks' WMPs
Asset management industry AUM
CAGR at 50% in 2011-2016
13.321.5
34.3
49.7
77.6
102 106
2011-16 CAGR
119%
21%
69%
42%
29%
129%
45%
Breakdown in 1H17
13%
2%
14%
9%
18%
17%
27%
Source: Deutsche Bank estimates, PBOC, CBRC, CSRC, AMAC, Trust Association, CIRC, Caixin
20 November 2017
Banks
Chinese banks
Deutsche Bank AG/Hong Kong Page 3
Who are the funding providers and how are the funds used?
We have collected financial data of funding sources and underlying assets for
each type of asset management product.
Fundingwise, as of year-end 2016, financial institutions provided 51%
of funding, the majority of which we believe are commercial banks.
This is followed by individual investors (31%) and corporates (18%).
Underlying asset wise, non-standard credit asset represented 36% of
total AUM, which are mostly loan-like fixed income assets. Bonds
represented 29% of total investment, followed by deposits and money
market funds (15%), equity and other securities (7%) and mutual fund
(2%).
Putting this into context of the entire system, if we account non-standard
assets and bonds as credit, then China’s asset management sector
contributed more than 80% of shadow banking credit, or approximately 18%
of total system non-financial credit.
Figure 2: Funding source versus underlying asset of asset management sector
Brokers' AM
schemes
(Rmb17.6trn)Trust investment
schemes
(Rmb17.5trn)
Public
mutual fund
(Rmb9.2trn)
Fund and fund
subsidiaries'
investment
schemes
(Rmb16.9trn)
Privatefunds
(Rmb10.2t
rn)
Retail investors (31%)
Corporates (18%)
Financial institutions (51%) Non-standard asset (36%)
Mutual fund (2%)
Others (11%)
Deposit and money market fund (15%)
Bond (29%)
Equity and other securities (7%)
Funding Source Underlying Asset
Bank's WMP
(Rmb29trn)
Insurance
investment
schemes (1.7trn)
Total asset management industry AUM at Rmb102trn as of end-2016; or
Rmb60-70trn if stripping out overlap.
China's asset management sector
Source: Deutsche Bank estimates, PBOC, AMAC, Trust Association, CIRC, CBRC, “Blue Book of Asset Management 2017” Note: The size of squares represents the size of AUM.
How did we get here, with such a notable asset management sector size?
In our view, the root cause of the proliferation of asset management AUM
was mainly due to GDP targeting and fragmented regulatory framework.
With a difficult to achieve targets of a certain level of GDP growth,
local governments and banks have strong incentives to grow loan
books. However, the fast-growing lending contradicts the tight
regulations faced by banks, including capital rules, loan quota and a
cap on loan-to-deposit ratio. This creates rising “financial innovation”
via various asset management plans to bypass those regulations.
The regulatory framework in China has been fragmented, as there has
been a lack of sufficient communications and coordination among the
four financial regulators in the past, as shown in Figure 3. As such
there were loopholes, which allowed financial institutions to conduct
20 November 2017
Banks
Chinese banks
Page 4 Deutsche Bank AG/Hong Kong
regulatory arbitrage activities. In some instances, there was even
competition between regulators, leading to aggressive expansion in
some asset management products.
Figure 3: China’s fragmented regulatory framework in the past
CBRC CSRC CIRC
Banks’ WMP(Rmb28tr)
Trust plans
(Rmb20tr)
Brokers’ AMPs
(Rmb18tr)
Public mutual fund
(Rmb10tr)
Fund and fund subs’ AMPs(Rmb15tr)
Private funds(Rmb9.5tr)
Insurance investment
funds(Rmb1.9tr)
PBOC
• Monetary policy• Macro-prudential assessment
China’s regulatory framework on asset management
businesses (in the past)
Source: Deutsche Bank, CBRC, CSRC, CIRC, PBOC Note: The size of squares represents the size of AUM
A little history of shadow banking – “Hide-and-seek”
The Chinese regulators were not unaware of the growing shadow credit.
Actually they have rolled out several regulations to tighten the risk controls
in previous years. However, the underlying root causes we mentioned above
were not addressed. So, at each new announcement, banks were always able
to come up with new ways to circumvent the then-existing rules. We
summarize previous regulations in below:
Circular 237 on interbank entrusted payment (August 2012): The
typical model of interbank entrusted payment is that banks book non-
standardized credit assets (NSCAs) under interbank assets with letters
of credit issued by other banks as collateral. As such, they could
charge only 20% risk weights and bypass the loan quota. In August
2012, the CBRC released Circular 237, which requires the entrusted
bank to book interbank entrusted payments under the loan category
and thus the risk weighting became 100% from 20% and the business
became subject to loan quota control.
Circular 8 on WMP (March 2013): Banks started to move their NSCAs
to off-b/s WMPs after the regulators cracked down on interbank
entrusted payments. In March 2013, the CBRC released Circular 8 to
curb the aggressive expansion of off-b/s credit-type WMPs. The
document clarifies the definition of NSCA and sets a cap at the lesser
of 35% of total WMPs and 4% of total assets.
Circular 127 on interbank assets (May 2014). As expansion of non-
standard WMPs was curbed by Circular 8, banks moved their NSCA
20 November 2017
Banks
Chinese banks
Deutsche Bank AG/Hong Kong Page 5
back to on-b/s interbank assets backed by trust beneficiary rights (TBR)
or bills. The majority of them are under the reserve repo category. In
May 2014, the CBRC released Circular 127 to tighten controls on on-
b/s interbank assets. The key points are: 1) reverse repo collateralized
by TBR are completely prohibited; 2) banks should charge provisions
and capital according to the nature of underlying assets. The rule
increases the cost of regulatory arbitrage through holding NSCA on
balance sheet.
Circular 82 on receivable investments (May 2016). Circular 127
effectively drove banks to move NSCA to receivable investments. As a
result, the receivable investment balance has increased strongly since
end-2014. Through deliberately structured transactions, banks still
manage to charge lower provisions and capital than required. The
latest Circular 82, which was released on 28 April, aims to tighten
oversight on NSCA transferred to off-b/s and encourages banks to
register their credit asset transfer on a centralized platform (Yindeng
Center) monitored by the CBRC. However, in our view, Circular 82 is
narrow in scope for now and we expect further regulations to contain
risks associated with rising shadow credit.
What are the key risks and proposed measures to lower those risks?
From the PBOC's perspective as highlighted in its 2017 financial stability report,
the key risks for the asset management sector include:
Liquidity risks due to duration mismatch
Contagion risks given multiple SPV layers
Under-capitalization and under-provisioning due to lack of proper
oversight on shadow banking
Implicit guarantees, which lift the actual risk free rate and deepen
moral hazard.
We hereby read into the PBOC’s new asset management rules from these four
key risks, and see how the central bank proposes to tackle the issues. We
summarize our findings in Figure 4.
20 November 2017
Banks
Chinese banks
Page 6 Deutsche Bank AG/Hong Kong
Figure 4: Asset Management Guideline mainly targets four key risks
Key risks Measures in new PBOC asset management (AM) business consultative guidance Impact
No asset pool operation; independent book management for each asset management product Lower product yield; increase transparency
Product issuance on a rolling basis to transfer risk and reward among different investors would be treated as
implicit guarantee behaviors
Lower product yield
Public raised product (e.g. bank WMP selling to mass market) should mainly invest in high liquidity fixed income
assets
Lower product yield
Only close-end product can invest in unlisted equity with product maturity longer than exit day of the unlisted
equity investment
Lower product yield; longer duration
Maturity of non-standardized credit invested should be no longer than maturity of close-end product or next open
day of open-end product
Longer product duration
Close-end product term should no shorter than 90 days Longer product duration
140%/200% leverage cap for open-end public fund/close-end public fund & private fund; 140% leverage cap for
tranched private funds
Lower product yield; lower leverage
For tranched private fund, senior tranche:equity tranche should below 3:1/2:1/1:1 for fixed income/mixed/equity
products
Lower product yield; lower leverage
Products under one asset manager cannot invest in a single listed stock exceeding 30% of its total free float;
Rmb30bn cap for investing in a single asset
Less liquidity risk
Allow a grace period until June 2019 for this new AM rules with no impact on existing products Less liquidity risk
AM product can invest in another AM product but only one layer is allowed (except for public raised mutual
funds)
Lower financing cost; lower credit growth
Asset managers cannot provide channel business for other financial institutions for regulatory & leverage
arbitrage
Lower financing cost; lower credit growth
Treat all asset managers in a fair manner to avoid regulatory arbitrage Lower financing cost
Financial institutions can entrusted an asset manager to invest on their behalf but the asset manager cannot invest
in AM products issued by others institutions (except public raised mutual funds)
Lower financing cost
Set up unified AM product information system; asset managers need to report their products to PBOC and
relevant regulators upon set up/expiry and on a monthly basis
Increase transparency; less regulatory arbitrage
Financial regulators should supervise asset managers by product type instead of institution type and identify
ultimate investor and underlying asset of each product
Increase transparency; less regulatory arbitrage
Clean up violation in asset management for non-financial institutions (e.g. internet companies) Lower financing cost; lower credit growth
Investment in non-standardized credit assets are under quota restriction, risk reserve requirement and liquidity
requirement
Lower product yield; lower credit growth
AM products cannot invest in restricted industry and areas Lower product yield; lower credit growth
Prohibit inappropriate connect transactions Lower product yield; lower credit growth
No implicit guarantee; all AM products should be managed based on NAV; at least weekly NAV report for public
fund
Less liquidity risk; lower product yield
Implicit guarantee activities by deposit-taking asset managers will be punished by paying equivalent deposit
required reserves, deposit insurance fees and penalties
Lower product yield; higher yield volatilities
No on-balance sheet AM business Deposit pressure for banks with high on-B/S WMP
Asset manager needs to set up risk reserves equal to 10% management fees until reaching 1% AUM Better investor protection
Clear classification of AM product type & qualified investors Better investor education
Independent AM operation from non-AM business More independence of bank WMP business
Third-party independent custodian account Better investor protection
Liquidity risks with asset pool
operation
Contagion risks given multiple
SPV layers
Shadow banking risks
Implicit guarantees risks
Source: Deutsche Bank, PBOC
First step – standardize product categorization
We think a vital area of progress in this new regulation is to standardize
classification of asset management products regardless of regulatory regimes.
The PBOC refers to asset management as financial institutions’ off-balance
sheet business to manage assets on behalf of customers, without any principle
or return guarantee. The new guidance covers asset management businesses
conducted by banks, trust companies, brokers, fund houses, future companies,
insurers, etc. It also specifies that financial institutions cannot conduct on-
balance sheet asset management business so on-B/S WMP will probably
transform into structured deposits, we think.
The PBOC broadly categorizes asset management products by investors into: 1)
publicly raised, and 2) privately raised. For the latter, only qualified investors
with a certain level of financial assets can invest and it requires a minimum
investment amount. Public funds are open to the mass market, which mainly
invest in low risk, high liquid fixed-income assets and listed stocks. Banks’
publicly raised WMPs should mainly invest in fixed income assets, and those
investing in equities and alternatives will need approval from CBRC (though no
approval is required for investing in debt-to-equity swap). Both public and
private funds need to report NAV on a regular basis and comply with leverage
cap. We summarize this product classification in Figure 5.
20 November 2017
Banks
Chinese banks
Deutsche Bank AG/Hong Kong Page 7
Figure 5: PBOC broadly classifies asset management products into two types, simplifying the product categorization
Currernt product classification - fragmented
and complicated
Product classification
under the new rulesInvestors Minimum investment Investment targets
Information
disclosure
Leverage cap
(asset/net asset)
Pubic raised product Mass market NA
Mainly low risk, high
liquidity fixed income
assets and listed
stocks
At least weekly NAV
report
140%/200% for open-
ended/closed ended
products
Private raised product Qualified investor*
Rmb300k/400k/1mn
for fixed
income/mixed/other
products
No constraintsAt least quarterly NAV
report
140%/200% for
tranchned/untranched
products
Brokers' AM
schemes
(Rmb17.6trn)Trust investment
schemes
(Rmb17.5trn)
Public
mutual fund
(Rmb9.2trn)
Fund and fund
subsidiaries'
investment
schemes
(Rmb16.9trn)
Privatefunds
(Rmb10.2t
Bank's WMP
(Rmb29trn)
Insurance
investment
schemes (1.7trn)
Source: Deutsche Bank, PBOC *Qualified investor definition” 1) Individuals with household financial assets >= Rmb5mn or annual income >= Rmb400k in recent 3 years with 2 years of investment experience; 2) Corporate entity with >= Rmb10mn net assets in recent 1 year.
Risk #1: Liquidity risks with asset pool operations
Asset pool operation refers to asset managers issuing products on a rolling
basis on a pool of investment assets without matching duration and pricing. In
many cases, short-term funds are used to invest in long-term non-standardized
credit or equities, leading to notable liquidity risks, not to mention the multiple
SPV layers and leverage involved in such products. One market expert
previously estimated that more than 50% current bank WMPs are operated
under asset pool (see our report: Financial deleveraging - takeaways from an
expert conference call dated on 19 July 2017).
In the guidance, asset pool operation is forbidden. Each asset management
product must manage the investment book independently by matching
duration of assets and funding. Maturity of non-standardized credit assets and
exit day of unlisted equity should be earlier than fund maturity date. Close-end
asset management product term should be no shorter than 90 days. In
addition, the document also specifies a leverage limit for asset management
products: 1) 140%/200% leverage cap for open-end public fund/close-end
public fund & private fund, 140% leverage cap for tranched private funds; 2)
for tranched private fund, senior tranche to equity tranche ratio should be
below 3:1/2:1/1:1 for fixed income/mixed/equity type products. The
requirement on leverage could potentially drive down leverage (Figure 6 & 7).
Figure 6: Overall leverage in NBFIs’ asset management
products have been rising…
Figure 7: … as has the interbank bond market
131.5% 131.6%
130.5%
135.3%
134.0%
134.7%
136.3%
127.0%
128.0%
129.0%
130.0%
131.0%
132.0%
133.0%
134.0%
135.0%
136.0%
137.0%
2014 1H15 2015 1H16 2016 1Q17 2Q17
Asset management overall leverage
(AUM of AM industry/(AUM - banks' credit to NBFIs)
1.08
1.37
1.12
1.77
0.80
1.00
1.20
1.40
1.60
1.80
2.00
2.20
2.40
(x)
Banks Insurance companies Funds Total Broker
Leverage in interbank bond market
Source: Deutsche Bank estimates, PBOC, CBRC, CSRC, AMAC
Source: Deutsche Bank estimates, PBOC, Chinabond.com.cn
20 November 2017
Banks
Chinese banks
Page 8 Deutsche Bank AG/Hong Kong
Risk #2: Contagion risks given multiple SPV layers
Banks would use other asset managers (e.g. trust, brokers, funds and insurers)
as SPV channels to achieve regulatory or leverage arbitrage, as banks cannot
invest own funds into equities and their credit deployment has many
restrictions (e.g. lending to local governments and property developers). This
creates contagion risks given the complex product structure and lack of
property due diligence.
The PBOC’s new guidance specifies that asset management products can
invest in other product but with only one layer allowed (except for investing in
publicly raised mutual funds), and no channel business can be provided.
Financial institutions are allowed to entrust other asset managers to invest on
their behalf. On the reporting front, the PBOC has opted to set up a unified
asset management product information system and requires asset managers
to report product information to the PBOC and relevant regulators upon set
up/expiry and on a monthly basis. On the regulation front, each financial
regulator should supervise asset managers by product type instead of
institution type and identify ultimate investor and underlying asset of each
product to minimize regulatory arbitrage.
How to measure the layers of SPVs in the financial system? We believe one
should look at financial assets to M2 ratio, where financial assets include all
banking assets and NBFI’s asset management product AUM. On a stock basis,
China’s total financial assets accounted for 2.1x M2, suggesting there are
slightly more than two layers to package the financing in China (Figure 8). On a
flow basis (Figure 9), the layers of SPVs to package new credit once surged to
4.3x in 2016, citing every 1 dollar M2 creation would need incremental 4.3
dollars of financial assets. However, post a series of tightening regulatory
treatment since 2H16, this has come down notably to only 1.1x in 2Q17. We
illustrate in detail in Appendix A of this report why the financial assets to M2
ratio is a good indicator for layers of SPVs in China.
Figure 8: Financial assets, including banking assets and
NBFIs AUM, have grown faster than M2, suggesting a
lengthening chain of financing…
Figure 9: … but financing chains have started to shorten
since 1Q17 due to tighter regulations
1.8x
1.8x
1.9x
2.0x
2.1x 2.1x2.1x
1.6x
1.7x
1.7x
1.8x
1.8x
1.9x
1.9x
2.0x
2.0x
2.1x
2.1x
2.2x
-
50
100
150
200
250
300
350
400
2014 1H15 2015 1H16 2016 1Q17 2Q17
Rm
b t
r
Total financial assets (banking assets + NBFI AUM)
M2
Financial assets/M2 (x, RHS)
2.53x
3.93x
3.09x
4.26x
1.99x
1.10x
0.60x
1.10x
1.60x
2.10x
2.60x
3.10x
3.60x
4.10x
4.60x
1H15 2015 1H16 2016 1Q17 2Q17
Δ (banking asset + asset management plans) / ΔM2 (x)
??
(x)
Source: Deutsche Bank, CBRC, PBOC, CSRC, AMA
Source: Deutsche Bank, CBRC, PBOC, CSRC, AMA
Risk #3: Shadow banking risks
Due to lack of effective and coordinated regulation, shadow banking activities,
which mean lending through non-loan and non-bond channels, have been very
active in the asset management industry. Banks are incentivized to lend off-
balance credit to avoid capital & provision rules and lending restrictions, which
20 November 2017
Banks
Chinese banks
Deutsche Bank AG/Hong Kong Page 9
are so called non-standardized credit assets. To lend out shadow credit, banks
cooperate with other asset managers to design asset management products
with complex SPV layers. Besides getting off-balance sheet WMP funding,
banks (especially smaller banks) also purchase non-standardized credit
products on balance sheet. In our study, we estimated shadow credit (mostly
in the form of receivable investment and off-B/S WMP products) accounted for
17% of non-big four listed banks’ total assets as of 1H17, which will trim their
CET-1 ratio by 1.1ppt in a stress testing scenario if lifting capital risk weight
and provision coverage on these assets.
Figure 10: Smaller banks have higher shadow banking
exposure
Figure 11: Non-big four banks could see 1.1ppt hit to
CET-1 ratio if lifting capital risk weight and provision on
shadow banking assets
3533
2926
24
20 20 19 18 18 18 17
12
53 3 2 1
2
17
8
0
5
10
15
20
25
30
35
40
(% of assets)Listed banks' exposure to shadow credit - 1H17
Off B/S NSCA in WMPs Reverse repo backed by bills/TBRs
Negligible
exposure at big-
four banks
6.9 6.6 6.7 6.68.3 8.3 7.8 7.7 7.7 7.4 7.5
11.4
7.3
10.7
12.912.811.4
10.311.9
8.310.4
8.6 8.6 8.88.3
9.8 9.9
8.98.5 8.6
8.2 8.4
12.4
8.3
11.0
13.0 12.9
11.410.4
12.0
9.4
10.9
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
(%) Impact on CET-1 ratio Adjusted CET-1 ratio
Mini. capital requirement
Source: Deutsche Bank, company data
Source: Deutsche Bank estimates, company data
In the PBOC’s new guidance, asset management products’ investment in non-
standardized credit assets are under quota restriction, risk reserve requirement
and liquidity requirement, and investments in restricted industries/areas are
prohibited. The current CBRC requirement (in Circular No. 8 issued in 2013) is
that non-standardized credit assets should not exceed 35% of WMP balance or
4% of total assets (whichever is lower). We cannot exclude the possibility that
the CBRC will issue stricter regulation to further contain off-balance sheet
shadow banking activities in the upcoming documents.
Risk #4: Implicit guarantee risks
Implicit guarantee is a widely discussed issue in China’s financial system,
especially in banks’ WMP business. In many cases, banks use own capital or
asset pool operation to provide guarantee on principal and return of issued
WMPs, which actually lifts the risk free rate in the system and pushes up the
social financing cost. This also deepens the moral hazard risk as WMP buyers
generally expect implicit guarantee from banks.
20 November 2017
Banks
Chinese banks
Page 10 Deutsche Bank AG/Hong Kong
Figure 12: WMP yield effectively became the actual risk free rate
-
1.0
2.0
3.0
4.0
5.0
6.0
7.0
Feb-09 Nov-09 Aug-10 May-11 Feb-12 Nov-12 Aug-13 May-14 Feb-15 Nov-15 Aug-16 May-17
DR007 3M WMP yield 10-year treasury yield Benchmark deposit rate - 1 year(%)
Source: Deutsche Bank, WIND, CEIC, PBOC
In the PBOC’s new guidance, it clearly states no implicit guarantee is allowed
and all products should be managed on NAV basis. It defines implicit
guarantee as either of the following cases: 1) asset managers promise principal
or return guarantee; 2) risks associated with current products are transferred to
other investors by issuing products on a rolling basis; and 3) financial
institutions use own capital or third party’s capital to compensate investment
loss. In addition, it also requires financial institutions to separate asset
management business from other non-asset management business to achieve
independent operation and account custodian. Finally, all asset managers need
to set aside risk reserves equivalent to 10% of management fees (until reserve
balance to 1% AUM) to compensate investors in case of wrong conduct.
What are the implications for the entire financial system?
In the near term, we do not expect any notable impact on system liquidity,
as the guidance allows a grace period of 19 months until June 2019 to
implement and the new rules during this period are only applied to new
products. In addition, there have been a couple of news reports and also the
PBOC has shed light in July 2017 in its Financial Stability Report 2017, so that
these regulations are largely in line with expectations.
But, in the near-to-medium term, as it suggests financial deleveraging will
continue, we expect the following changes:
System credit growth to moderate (Figure 13), so slowing the build-up
in financial leverage (Figure 14)
Shadow banking balance to shrink, especially for those regulatory
arbitrage activities (Figure 15 and 16)
Banking asset growth to stay low (Figure 17), and highly-levered
banks may continue to shrink balance sheet (Figure 18)
Borrowerwise, better-quality borrowers may enjoy lower funding costs,
as the layers of SPVs will be reduced. But, weaker borrowers are likely
to see funding costs increase.
20 November 2017
Banks
Chinese banks
Deutsche Bank AG/Hong Kong Page 11
Figure 13: Credit growth is likely to further moderate Figure 14: The leverage built-up is likely to slow
13.0%
14.9%
10%
15%
20%
25%
30%
35%
40%TSF stock yoy TSF stock (adj.) yoy
206%
140%
150%
160%
170%
180%
190%
200%
210%
220%M2 / 12M rolling GDP
Source: Deutsche Bank, PBOC
Source: Deutsche Bank, PBOC
Figure 15: Shadow banking has been shrinking, including
1) banks’ WMP AUM…
Figure 16: … and 2) banks’ on-B/S shadow banking
exposure (i.e. receivable investment)
2.7 4.67.1
10.215.0
23.5
29.1 29.1 28.4 28.4
3.7%
5.6%
7.5%
9.5%
12.8%
16.8%
18.7%18.0% 17.5% 17.2%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
16.0%
18.0%
20.0%
0.0
5.0
10.0
15.0
20.0
25.0
30.0
35.0
Oustanding WMP balance As % of total deposits (RHS)(Rmb trn)
-3,000
2,000
7,000
12,000
17,000
22,000
Rmb bn Receivable investment balance by banks
Big-4 CDB+PSBC+BOCOM Medium/small banks
Source: Deutsche Bank, CBRC
Source: Deutsche Bank, PBOC
Figure 17: China banking assets growth to slow down… Figure 18: … driven mainly by smaller banks
15.7%
10.2%10.0%
12.0%
14.0%
16.0%
18.0%
20.0%
22.0%
24.0%
26.0%
28.0%
30.0%
China banking assets yoy growth
8.5%
6.7%
16.2%
11.3%
14.5%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
Banking assets yoy growth by typeLarge commercial bank Joint-stock commercial bank
City commercial bank Rural financial institutions
Policy banks & other FIs
Source: Deutsche Bank, PBOC
Source: Deutsche Bank, PBOC, CBRC
However, we see the new regulation as a long-term positive for the entire
financial system
This is the first regulation to target the entire asset management
sector and to be issued after the establishment of Financial Stability
Development Committee, the new committee that is at higher level
20 November 2017
Banks
Chinese banks
Page 12 Deutsche Bank AG/Hong Kong
than the central bank. So it suggests that regulatory coordination has
been strengthened, which should address the root cause of strong
growth in China’s shadow banking. We expect the new committee to
curb the regulatory arbitrage of shadow banking by closing loopholes
and reducing regulatory competition (Figure 19). This, in our view,
should contain the growth and reduce the murkiness of China’s
shadow banking system.
Figure 19: China’s regulatory framework is shifting towards being more coordinated, as the new committee has been
set up on top of all current regulators
CBRC CSRC CIRC
Banks’ WMP(Rmb28tr)
Trust plans
(Rmb20tr)
Brokers’ AMPs
(Rmb18tr)
Public mutual fund
(Rmb10tr)
Fund and fund subs’ AMPs(Rmb15tr)
Private funds(Rmb9.5tr)
Insurance investment
funds(Rmb1.9tr)
PBOC
• Monetary policy• Macro-prudential assessment
China’s regulatory framework on asset management
businesses (in the past)
CBRC CSRC CIRC
Banks’ WMP(Rmb28tr)
Trust plans
(Rmb20tr)
Brokers’ AMPs
(Rmb18tr)
Public mutual fund
(Rmb10tr)
Fund and fund subs’ AMPs(Rmb15tr)
Private funds(Rmb9.5tr)
Insurance investment
funds(Rmb1.9tr)
PBOC
• Monetary policy• Macro-prudential assessment
China’s regulatory framework (at present)
Financial Stability and Development Committee
Source: Deutsche Bank, PBOC, CBRC, CIRC, CSRC Note: The size of squares represents the size of AUM
We expect banks’ wealth management businesses to transform into
something similar to close-end mutual funds, investing in low-risk,
high-liquid assets with longer duration. In this process, banks’ WMP
yield would gradually come down, as the WMPs invest low-risk assets
with less duration mismatch. This should help lower the actual risk
free rate and strengthen risk pricing and monetary policy transmission,
thus improving the capital allocation in the system.
Figure 20: WMP yield is likely to fall over the long run
-
1.0
2.0
3.0
4.0
5.0
6.0
7.0
Feb-09 Nov-09 Aug-10 May-11 Feb-12 Nov-12 Aug-13 May-14 Feb-15 Nov-15 Aug-16 May-17
DR007 3M WMP yield 10-year treasury yield Benchmark deposit rate - 1 year(%)
Source: Deutsche Bank estimates, WIND, CEIC, PBOC
20 November 2017
Banks
Chinese banks
Deutsche Bank AG/Hong Kong Page 13
What are the implications for individual banks?
With elevated shadow banking exposure and lower degree of compliance,
smaller banks are likely to face persistent capital and earnings risks. As WMP
yield might fall, it would become harder for them to grow deposits thus adding
funding pressure. In contrast, big banks should benefit from better loan
demand and stable deposit growth.
As shown in Figure 21, listed banks’ non-standard asset exposure combined
with their on- & off- B/S wealth management products accounted for c.20% of
total asset in 1H17, where large banks’ exposure to these highly-scrutinized
products only represented high single to low teens of total assets. On the flip
side, smaller banks saw 24-57% asset exposure, which are highly likely to
suffer from the stricter regulatory treatment on asset management industry.
Figure 21: Banks’ NSCA and on & off B/S as % of total asset (1H17)
57 54
45 44 44 43 41 38 38 38 37 34
24
11 10 8 7
9
38
20
0
10
20
30
40
50
60
(% of assets) Listed banks' exposure to NSCA and WMPs (on & off) 1H17
Off B/S WMPs On B/S WMPs On B/S NSCA in reverse repo and receivable investment
Less exposure at
big-four banks
Source: Deutsche Bank, company data
20 November 2017
Banks
Chinese banks
Page 14 Deutsche Bank AG/Hong Kong
Appendix A – Layers of SPVs
One of the factors driving the strong growth in banking assets and NBFI’s
AUM in past years is the lengthening of financing chains, i.e. the funds to the
real economy have been packaged via multiple channels or SPVs. The
regulators have made themselves very clear in targeting the cutting off of
these excessive layers.
We illustrate below how the financing chains work:
Example 1: Three layers of financing channels
Large bank borrows Rmb1 from the PBOC, booked as borrowing from
the PBOC in liability and then lends it out to smaller banks, booked as
lending to banks.
Smaller bank booked it as interbank liability and then lends it out to an
NBFI, booked as credit to NBFI.
NBFI follows to lend the Rmb1 to a corporate, who will book it as bank
debt in liability. However, corporates sometimes may not have the
need for FAI, it just saves the money with large banks as deposit.
In this case, total financial assets, including the big bank, smaller bank
and NBFI, should total Rmb4. However, there is only Rmb1 deposit.
Example 2: Four layers of financing channels
The process goes the same as for example 1 in the first two steps. As
NBFI A receives Rmb1 from the small bank, it may lend it out to NBFI
B, booked as borrowing from banks.
NBFI B may consider a) lending the money to corporate, and then the
money will return to the banks as deposit, or b) lending to other
smaller banks or NBFIs.
Above option a) will create at 4x leverage, or above 4x if it chooses to
lend the money to other smaller banks/NBFIs. The money will keep
circulating in the financial sector, creating leverage with less real
benefit to real economy.
20 November 2017
Banks
Chinese banks
Deutsche Bank AG/Hong Kong Page 15
Figure 22: Two scenarios illustrating the lengthening financing chains
Layer #1 Layer #2 Layer #3
Large bank Smaller bank NBFI A (e.g. trust) Croporates
Asset Liabil ities Asset Liabil ities Asset Liabil ities Asset Liabil ities
Lending to banks 1 Borrow from PBOC 1 Credit to NBFI 1 Due from banks 1 Loans 1 Due from banks 1 Deposit 1 Loans 1
Cash 1 Deposit 1 (Receivable investment)
Layer #1 Layer #2 Layer #3 Layer #4
Large bank Smaller bank NBFI A (e.g. trust) NBFI A (e.g. brokers) Croporates
Asset Liabil ities Asset Liabil ities Asset Liabil ities Asset Liabil ities Asset Liabil ities
Lending to banks 1 Borrow from PBOC 1 Credit to NBFI 1 Due from banks 1 Credit to 1 Due from banks 1 Loans 1 Borrowing from 1 Deposit 1 Loans 1
Cash 1 Deposit 1 (Receivable investment) NBFI NBFI
Financial institutions (banks and NBFIs) balance sheet
Example 1: Three layers created $4 financial assets Example 2: Four layers created $5 financial assets
Asset 4 Liabil ities 4 Asset 5 Liabil ities
Lending to banks 1 Borrow from PBOC 1 Lending to banks 1 Borrow from PBOC 1
Credit to NBFI 1 Due from banks 2 Credit to NBFI 2 Due from banks 2
Cash 1 Deposit 1 Cash 1 Deposit 1
Loans 1 Loans 1 Borrowing from NBFI 1
Three layers Four layers
Financial assets : deposits = 4 :1 Financial assets : deposits = 5 :1 ``
1
1 2
2
Source: Deutsche Bank
To put this into a formula to quantify layers of SPVs, we can calculate as below:
We believe this is a good method to assess the financial sector by factoring in
the layer effect in circulating funds. Based on the results, we believe the
expanding circulating chain was the main reason for leverage-up in the
financial sector. The layers of SPVs to package new credit surged to 4.3x in
2016, citing every 1 dollar M2 creation would need incremental 4.3 dollars of
financial assets. However, post a series of tightening regulatory treatment
since 2H16, this has come down notably to only 1.1x in 2Q17.
This unwinding of multiple layers of channels should help reduce the funding
cost of underlying borrowers. However, the leveraged banks and NBFIs would
be hurt due to lower earnings.
20 November 2017
Banks
Chinese banks
Page 16 Deutsche Bank AG/Hong Kong
Valuation and risks
Valuation of Chinese banks
We value Chinese banks using a three-stage Gordon Growth Model (PV= (ROE-
g)/(COE-g)), with target prices based on 2017E book values.
Our valuations of the Chinese banks under our coverage assume a near-term
(2016-18E) ROE of 11.5-16.9%, a medium-term (2019-21E) ROE of 10.5-14.0%
and a terminal ROE of 8.0-12.0%, with a COE of 11.5-14.0%. In Figure 23, we
highlight our valuation comparison of the listed banks.
In our estimates, H-share/A-share listed Chinese banks are trading at 2017E
P/B of 0.83x/0.97x and 2017E P/E of 6.18x/7.24x.
Figure 23: Chinese banks’ valuation summary
Ticker Rating TP Price Upside Mkt. Cap
LC LC (%) (US$mn) 16A 17E 18E 16A 17E 18E 16A 17E 18E 16A 17E 18E 16A 17E 18E 16A 17E 18E
ICBC-H 1398.HK Buy 6.52 6.19 5.3% 314,138 7.1 6.6 6.3 1.0 0.9 0.8 4.3 3.9 3.5 15.2% 14.3% 13.6% 1.20% 1.15% 1.11% 4.3% 4.6% 4.9%
CCB-H 0939.HK Buy 7.68 6.81 12.8% 219,712 6.5 6.0 5.7 1.0 0.8 0.8 3.9 3.4 3.1 15.5% 14.7% 13.9% 1.18% 1.13% 1.10% 4.6% 5.0% 5.3%
ABC-H 1288.HK Buy 4.10 3.62 13.3% 176,672 5.8 5.3 5.0 0.8 0.7 0.7 3.3 2.9 2.6 15.1% 14.5% 13.8% 0.99% 0.96% 0.94% 5.3% 5.9% 6.1%
BOC-H 3988.HK Buy 4.78 3.78 26.5% 165,155 6.2 5.6 5.3 0.7 0.7 0.6 3.2 2.9 2.5 12.5% 12.2% 12.0% 0.94% 0.91% 0.89% 5.0% 5.5% 6.0%
BCOM-H 3328.HK Buy 6.53 5.82 12.2% 62,931 5.8 5.4 5.2 0.7 0.6 0.5 3.3 3.0 2.7 12.2% 11.4% 10.9% 0.87% 0.81% 0.77% 5.3% 5.5% 5.8%
CMB-H 3968.HK Hold 26.27 31.30 -16.1% 109,865 11.2 9.6 8.5 1.7 1.5 1.3 4.8 4.2 3.8 16.3% 16.2% 16.4% 1.09% 1.12% 1.17% 2.7% 3.1% 3.5%
CITIC Bank-H 0998.HK Hold 4.67 5.02 -7.0% 41,067 5.2 5.0 4.8 0.6 0.6 0.5 2.0 1.9 1.8 12.6% 11.7% 11.0% 0.75% 0.69% 0.68% 4.8% 3.0% 3.1%
Minsheng-H 1988.HK Hold 7.80 7.51 3.9% 44,754 5.1 4.7 4.5 0.7 0.6 0.6 2.4 2.3 2.1 15.1% 13.9% 13.0% 0.94% 0.82% 0.82% 4.2% 3.2% 3.3%
CEB-H 6818.HK Sell 3.24 3.66 -11.5% 27,792 5.2 4.9 4.8 0.7 0.6 0.5 2.4 2.2 2.0 13.8% 12.7% 11.6% 0.85% 0.74% 0.70% 3.0% 0.0% 0.0%
CRCB 3618.HK Hold 6.05 5.31 13.9% 6,322 5.5 4.8 4.4 0.8 0.7 0.6 3.3 2.7 2.3 16.0% 15.7% 15.0% 1.05% 1.05% 1.04% 4.3% 4.2% 4.5%
Huishang 3698.HK Sell 3.14 3.95 -20.5% 5,587 5.6 5.0 4.7 0.8 0.7 0.6 2.5 2.3 2.2 15.8% 15.1% 14.1% 0.99% 0.96% 0.95% 1.8% 2.0% 2.1%
BOCQ 1963.HK Sell 5.65 6.16 -8.3% 2,466 4.9 4.3 4.0 0.7 0.6 0.5 2.4 2.0 1.9 15.5% 15.2% 14.6% 1.01% 1.00% 1.00% 5.3% 6.1% 6.5%
H-share sector mean 6.8 6.2 5.8 1.0 0.8 0.8 3.7 3.3 3.0 14.7% 14.0% 13.4% 1.07% 1.02% 1.00% 4.5% 4.7% 5.0%
ICBC-A 601398.SS Buy 5.98 6.03 -0.8% 314,138 7.8 7.6 7.2 1.1 1.0 0.9 4.8 4.4 4.0 15.2% 14.3% 13.6% 1.20% 1.15% 1.11% 3.9% 4.0% 4.2%
CCB-A 601939.SS Buy 7.04 6.99 0.7% 219,712 7.6 7.3 6.9 1.1 1.0 0.9 4.5 4.1 3.8 15.5% 14.7% 13.9% 1.18% 1.13% 1.10% 4.0% 4.1% 4.4%
ABC-A 601288.SS Hold 3.75 3.66 2.5% 176,672 6.6 6.3 6.0 1.0 0.9 0.8 3.8 3.4 3.1 15.1% 14.5% 13.8% 0.99% 0.96% 0.94% 4.6% 4.9% 5.1%
BOC-A 601988.SS Buy 4.38 3.92 11.7% 165,155 7.3 6.9 6.4 0.9 0.8 0.7 3.7 3.5 3.1 12.5% 12.2% 12.0% 0.94% 0.91% 0.89% 4.3% 4.5% 4.9%
BCOM-A 601328.SS Hold 5.98 6.22 -3.9% 62,931 7.0 6.8 6.5 0.8 0.7 0.7 4.0 3.8 3.4 12.2% 11.4% 10.9% 0.87% 0.81% 0.77% 4.4% 4.4% 4.6%
CMB-A 600036.SS Hold 24.06 29.38 -18.1% 109,865 11.9 10.7 9.4 1.8 1.6 1.4 5.1 4.7 4.2 16.3% 16.2% 16.4% 1.09% 1.12% 1.17% 2.5% 2.8% 3.2%
CITIC Bank-A 601998.SS Sell 4.28 6.13 -30.2% 41,067 7.2 7.1 6.9 0.9 0.8 0.7 2.8 2.7 2.6 12.6% 11.7% 11.0% 0.75% 0.69% 0.68% 3.5% 2.1% 2.2%
Minsheng-A 600016.SS Sell 7.15 8.54 -16.3% 44,754 6.5 6.4 6.1 0.9 0.8 0.7 3.1 3.1 2.8 15.1% 13.9% 13.0% 0.94% 0.82% 0.82% 3.3% 2.4% 2.5%
SPDB 600000.SS Hold 12.75 12.78 -0.2% 56,613 5.4 5.2 4.9 0.8 0.7 0.6 2.3 2.1 2.0 16.5% 14.7% 13.6% 0.94% 0.89% 0.86% 1.6% 1.6% 1.7%
Industrial Bank 601166.SS Sell 14.92 17.36 -14.1% 54,428 6.3 6.2 5.9 1.0 0.9 0.8 2.9 2.9 2.7 17.1% 15.5% 14.4% 0.89% 0.87% 0.87% 3.5% 1.6% 1.7%
CEB 601818.SS Sell 2.97 4.09 -27.4% 24,574 6.5 6.4 6.3 0.9 0.8 0.7 3.0 2.9 2.7 13.8% 12.7% 11.6% 0.85% 0.74% 0.70% 2.4% 0.0% 0.0%
Ping An Bank 000001.SZ Hold 9.48 13.18 -28.1% 34,154 10.0 9.6 9.1 1.2 1.1 1.0 3.0 2.8 2.7 13.1% 12.2% 11.5% 0.83% 0.81% 0.79% 1.2% 0.0% 0.0%
Bank of Beijing 601169.SS Buy 9.34 7.45 25.4% 20,517 6.4 7.1 6.5 0.9 1.0 0.9 3.3 3.6 3.2 14.9% 14.5% 14.1% 0.90% 0.91% 0.91% 3.4% 3.0% 3.3%
Bank of Nanjing 601009.SS Sell 5.65 8.13 -30.5% 10,408 6.1 7.8 7.1 0.9 1.2 1.0 2.6 3.6 3.2 16.2% 15.9% 15.0% 0.86% 0.79% 0.78% 3.2% 0.0% 0.0%
Bank of Ningbo 002142.SZ Sell 9.37 17.90 -47.7% 13,696 9.2 10.8 10.2 1.5 1.7 1.5 4.7 5.1 4.5 17.7% 17.1% 15.9% 0.98% 0.92% 0.89% 2.0% 1.7% 1.8%
A-share sector mean 7.5 7.2 6.8 1.1 1.0 0.9 4.0 3.7 3.4 14.7% 13.9% 13.3% 1.03% 0.99% 0.97% 3.6% 3.5% 3.7%
Div. Yield (%)ROAAROAEP/PPOPP/B (x)P/E (x)
Source: Deutsche Bank estimates, Bloomberg Finance LP; Note: market cap is sum of A and H shares; data as of 17 Nov 2017
Risks for Chinese banks
Key sector risks for Chinese banks Disorderly deleveraging: the government could place disorderly
deleveraging requirements on specific industries, which might
unexpectedly lead to a bank run and squeeze banks’ wholesale
funding.
Over-tightening in real estate and infrastructure: If both industries
saw unfavourable credit conditions, the overall banking system might
have little chance to avoid asset quality deterioration.
Significant property price corrections: NPL ratios usually surge
following an over-correction in property market prices, according to
historical experience. For example, Wenzhou’s NPL ratio surged by
20 November 2017
Banks
Chinese banks
Deutsche Bank AG/Hong Kong Page 17
4.3ppt to 4.7%, accompanying a 47% price correction in the city’s
property market.
CPI picks up and the PBOC is forced to hike benchmark rates: a
potential benchmark rate hike in the near term will likely be more
harmful to corporates (higher interest burden), which cannot be fully
offset by profitability recovery under better economic growth,
considering that corporates’ leverage ratio remains at a higher level, in
spite of the mild improvement recently.
Larger-than-expected DES size given potentially stronger
government invention. Without strict selection criteria on the viability
of target companies, it could potentially ‘evergreen’ the debts of
zombie companies, worsen capital allocation and raise investment risk
for banks.
Key upside risks for the sector:
Removal of the softening of GDP targets: In the long run, we think
this movement will likely be meaningfully positive for banks’ RoE/RoA,
as most of the legacy NPLs are disposed within the near term (two to
three years) and banks should have notably lighter credit cost burdens
in the future.
More aggressive SOE reform to push forward privatization: SOEs are
likely to be more market-oriented, profitability might be better and
asset quality will likely recover accordingly. As of now, we are seeing
improving conditions at industrial SOEs, while non-industrial SOEs still
seem to be struggling. We are closely tracking SOEs’ profitability and
ROE.
Pick-up in private investment by further deregulation and favourable
policies. Private companies in general are more productive and
efficient than SOEs. A leading indicator could be a pick-up in private
companies’ debt growth, which is muted for now.
The authors of this report wish to acknowledge the contribution made by Vivian
Xu, an employee of Evalueserve, a third-party provider to Deutsche Bank of
offshore research support services.
20 November 2017
Banks
Chinese banks
Page 18 Deutsche Bank AG/Hong Kong
Appendix 1
Important Disclosures
*Other information available upon request
Prices are current as of the end of the previous trading session unless otherwise indicated and are sourced from local exchanges via Reuters, Bloomberg and other vendors . Other information is sourced from Deutsche Bank, subject companies, and other sources. For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr. Aside from within this report, important conflict disclosures can also be found at https://gm.db.com/equities under the "Disclosures Lookup" and "Legal" tabs. Investors are strongly encouraged to review this information before investing.
Analyst Certification
The views expressed in this report accurately reflect the personal views of the undersigned lead analyst about the subject issuers and the securities of those issuers. In addition, the undersigned lead analyst has not and will not receive any compensation for providing a specific recommendation or view in this report. Hans Fan
Equity rating key Equity rating dispersion and banking relationships
Buy: Based on a current 12- month view of total share-holder return (TSR = percentage change in share price from current price to projected target price plus pro-jected dividend yield ) , we recommend that investors buy the stock.
Sell: Based on a current 12-month view of total share-holder return, we recommend that investors sell the stock
Hold: We take a neutral view on the stock 12-months out and, based on this time horizon, do not recommend either a Buy or Sell.
Newly issued research recommendations and target prices supersede previously published research.
56 %
33 %
11 %17 %17 % 11 %
0
100
200
300
400
500
600
Buy Hold Sell
Asia-Pacific Universe
Companies Covered Cos. w/ Banking Relationship
20 November 2017
Banks
Chinese banks
Deutsche Bank AG/Hong Kong Page 19
Additional Information
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Macroeconomic fluctuations often account for most of the risks associated with exposures to instruments that promise
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Deutsche Bank AG/Hong Kong Page 21
German Banking Law and is subject to supervision by the European Central Bank and by BaFin, Germany’s Federal
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Copyright © 2017 Deutsche Bank AG
David Folkerts-Landau Group Chief Economist and Global Head of Research
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Research
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Global Head of Economics
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Equity Research
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Equity Research
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Equity Derivatives Research
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and QIS Research
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