Foreign banks warn over China lending limit rules

Foreign banks in China have warned that they will suffer severe “collateral damage” from new rules aimed at limiting off-balance sheet lending by domestic banks.

Beijing has drafted regulations to restrict interbank loans after financial institutions used them to circumvent government-imposed credit controls. The restrictions are directed at domestic banks that have aggressively increased their interbank business in recent years, but foreign banks, already struggling in China, fear they will be caught in the crossfire.

If the new rules were to go into force as currently drafted, international banks would lose a critical source of funding and revenue for their operations, foreign bankers told the Financial Times.

“They have not thought about the impact on foreign banks. We will just be collateral damage in their crackdown,” said a senior executive with a midsized foreign bank based in Shanghai. “The regulations are well-intentioned but could completely undermine our business model.”

The head of a second midsized foreign bank expressed similar concerns. People familiar with the auto-financing industry are also worried that these companies, an increasingly important part of the Chinese car market, would be hurt.

Interbank assets have more than doubled during the past three years, with banks disguising loans to companies as loans to other banks, thereby skirting ceilings on credit issuance and also evading tougher capital requirements.

“Regulators are concerned as the interbank market has increasingly funded shadow banking,” said Mike Werner, an analyst with Sanford C. Bernstein.

Unlike domestic rivals, for foreign institutions, the interbank market has not been used as a conduit for shadow banking. Rather, it has served two purposes. First, for those with weak deposit bases – a reality for almost all foreign banks in China – interbank borrowing has been an essential part of their funding mix. Second, when foreign banks do receive sizeable deposits, often from multinational companies, they rely on the interbank market to get higher returns.

The regulations would hit both sides of the equation. According to the draft, interbank borrowing or lending would not be allowed to exceed 50 per cent of a bank’s deposit base. The China Banking Regulatory Commission did not reply to requests for comment.

Auto-financing companies would also be squeezed because the draft rules stipulate that lending to non-bank financial institutions should not exceed 25 per cent of a bank’s net capital.

For important players in the auto-financing industry including units of GM, BMW and Volvo, the combination of borrowing from banks directly and from the interbank market can account for nearly half of their funding, according to Gordon Xie, a partner with Deloitte China. He said the new banking regulations would narrow their options, pushing them to consider alternatives.

“The leading auto-financing companies are thinking about different ways to get funding, like asset-backed securities, listings or issuing bonds,” Mr Xie said.

The largest foreign banks in China by deposits such as HSBC are expected to be less affected by the rules because they have a bigger base of corporate and retail clients, but such cases are unusual.

“Foreign banks have very high cost bases and they struggle to get retail deposits,” said an auditor with a top international accountancy firm. “The trend is tough.”