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The Tri-Forces of De-leveraging

Jan 08-2020   



 

To understand the impact of de-leveraging on private enterprises, it’s imperative to consider how leveraging was rammed up in the first place, said Assistant Prof. Hu Jiayin of the NSD at the recently held National Development Forum.

 

Chinese firms rely on banks for roughly 80% of their financing, in stark contrast to their US counterparts, which get 80% of their financing directly from the financial markets. The development of shadow banking in China is therefore closely tied to such a traditional banking system. Rather than a supervisory arbitrage, shadow banking in effect acts as key financing channel for private enterprises.

 

De-leveraging has been rolled out by the government in a bid to pre-empt systemic risks but might have dealt an additional blow to private firms. Prof. Hu came away with this impression when interviewing private business owners together with Prof. Yao Yang, Dean of the NSD, over the summer.

 

The blow dealt to private firms comes from three forces. In the debt market, a new regulation on asset management released in April 2018 has cut off capillaries carrying liquidity from shadow banking to private enterprises. The widening interest rate spread between non-SOEs and SOEs since the implementation of the new regulation points to the former’s significantly higher financing costs.

 

Constrained by limited financing channels, private entrepreneurs turn to the equity market where they put their shareholdings as collaterals to secure financing. Yet when a stock price slumps to a certain level, those shares are closed out and the business owners lose their majority control of their firms. Consequently, the companies are thrown into operational disarray.

 

The third force concerns the small and medium-sized banks, which used to be the main financing channel for private firms. The Baoshang Bank incident disavowed the formerly risk-free character of inter-banking market, resulting in sharp rise in inter-banking interest. As small and medium-sized banks languish, so do their financing support for private firms.

 

Private firms are believed to account for 60% of China’s GDP, 70% of all innovations, 80% of urban employment and 90% of newly created jobs. How to bolster their development remains a key issue, said Prof. Hu.

The Tri-Forces of De-leveraging

Jan 08-2020   



 

To understand the impact of de-leveraging on private enterprises, it’s imperative to consider how leveraging was rammed up in the first place, said Assistant Prof. Hu Jiayin of the NSD at the recently held National Development Forum.

 

Chinese firms rely on banks for roughly 80% of their financing, in stark contrast to their US counterparts, which get 80% of their financing directly from the financial markets. The development of shadow banking in China is therefore closely tied to such a traditional banking system. Rather than a supervisory arbitrage, shadow banking in effect acts as key financing channel for private enterprises.

 

De-leveraging has been rolled out by the government in a bid to pre-empt systemic risks but might have dealt an additional blow to private firms. Prof. Hu came away with this impression when interviewing private business owners together with Prof. Yao Yang, Dean of the NSD, over the summer.

 

The blow dealt to private firms comes from three forces. In the debt market, a new regulation on asset management released in April 2018 has cut off capillaries carrying liquidity from shadow banking to private enterprises. The widening interest rate spread between non-SOEs and SOEs since the implementation of the new regulation points to the former’s significantly higher financing costs.

 

Constrained by limited financing channels, private entrepreneurs turn to the equity market where they put their shareholdings as collaterals to secure financing. Yet when a stock price slumps to a certain level, those shares are closed out and the business owners lose their majority control of their firms. Consequently, the companies are thrown into operational disarray.

 

The third force concerns the small and medium-sized banks, which used to be the main financing channel for private firms. The Baoshang Bank incident disavowed the formerly risk-free character of inter-banking market, resulting in sharp rise in inter-banking interest. As small and medium-sized banks languish, so do their financing support for private firms.

 

Private firms are believed to account for 60% of China’s GDP, 70% of all innovations, 80% of urban employment and 90% of newly created jobs. How to bolster their development remains a key issue, said Prof. Hu.