Banking & Finance

Product recall

An end to trust-lending

Product recall

It’s the kind of thing crises are made of – a financial institution exposing itself to a huge amount of risk for a small amount of return. And this is exactly what China’s trust companies have done with their enthusiasm for trust-lending (see WiC74). Trust loans now account for 10% of their profits, and two-thirds of their assets, reports Reuters.

The practice is popular with banks because offloading a loan to a trust company means that the debt goes off balance sheet, thus allowing the bank to continue lending. But the government dealt a blow to the banks last month when it decreed that all debt that had been sold to trust companies must go back onto their own books.

Last week the government put the final nail in the trust-loan coffin by targeting the lightly regulated industry. The banking regulator – the CBRC – is demanding that trust firms hold net capital of at least Rmb200 million or 40% of net assets. Companies have 12 months to comply.

In practical terms that marks the end of the recent explosion of trust-lending. Why? Because the new capital requirements will divert resources from the trusts’ core activity, the funds business. Trust-lending is 10 times less profitable than the funds business – so when faced with the choice of scaling back either business, the trust-loan is the no-brain choice.

“In the past, trust companies were content to gain at least something from bank-trust cooperation,” one general manager of a trust company told 21CN Century Business Herald. “But now the opportunity cost is too high.”

The newspaper reckons trust-lending was popular with trust companies because it didn’t require much of their time or energy – it was mostly about maintaining a good relationship with the banks. Now that it is being discouraged, they will return to a focus on their traditional business.

The real losers could be property developers, who will lose access to a major source of capital. Developers turned to trust loans when the government ordered banks to slow down their lending to the overheating property sector. If all goes to plan, the net result could be that houses become a little cheaper.

The move reflects well on the regulator, which seems to have learned from America’s housing-inspired financial crisis in 2008 that pre-emptive measures are preferable to the pain of mopping up that inevitably follows the bubble bursting.

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