Growth in shadow banking in China is slowing due to coordinated government action to contain systemic financial risks, a development that will benefit banks, although it will also bring adjustment risks, Moody’s Investors Service said in a report Tuesday.

The ratings agency’s analysis showed the effectiveness of coordinated measures by authorities by the central bank, the banking and securities regulators “to slow runaway growth in shadow banking.”

Actions included the central bank changing its monetary policy setting in the last quarter of 2016 to “moderate neutral” from “moderate,” which raised market funding costs and refinancing risks for banks, reducing the return from supporting long-term investments with short-term market funds, said Moody’s.

In March and April, the China Banking Regulatory Commission also requested banks test whether their interbank liabilities would exceed the regulatory ceiling at one-third of total liabilities.

“This unified approach by regulators contrasts with previous piecemeal clampdowns from single authorities in various jurisdictions to control shadow banking products, which were vulnerable to regulatory arbitrage and difficult to be stringently enforced,” Moody’s analysts added.

The ratings agency’s report came as China’s central bank said on Tuesday that the shadow banking sector lacks sufficient regulation, Reuters reported. The central bank will increase supervision over the rapidly growing asset management industry to curb shadow-banking risks, it said.

In its report, Moody’s said it has seen signs of a reversal in shadow-banking growth, with on-year growth of broad money aggregate defined under M2 slowing to 9.6 percent in May 2017 — a record low since data was first available in 1986.

The slowdown was led by weak deposit growth of just 1.8 percent in non-depository financial institutions, such as securities companies and mutual fund management companies.

Within the banking system, the balance of wealth management products issued by Chinese banks fell to 28.4 trillion yuan ($4.18 trillion) at the end of May, from 29.1 trillion yuan ($4.28 trillion) at the end of 2016.

Moody’s data complied from 26 listed banks also showed investments in loans and receivables fell to 11.8 trillion yuan ($1.74 trillion) at the end of 2016 from 12.1 trillion yuan ($1.74 trillion) at the end of June 2016.

The developments were overall credit positive for Chinese banks, but they come with “adjustment risks,” added Moody’s.

“The slowdown in shadow banking is likely to prompt disputes among financial institutions
over the responsibility for absorbing losses on soured investments,” said Moody’s.

“The rapid rise of bank loans and trust loans in 2017, which offset the decline in bond issuance and shadow-bank financing, will strain the capital of banks and trust companies,” the ratings agency added.

The risks will challenge the commitment of authorities to stick to its hardline stance in restraining shadow banking, said Moody’s.

“Instead, authorities may take a measured approach with their policies because they are mindful of the potential adverse impact on economic growth and financial stability,” said the analysts.

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