Debunking China myths: Will tighter financial regulations lead to credit crunch?

By CGTN’s Wang Yue

China's financial industry is in the midst of driving unwanted leverage out of the sector. And the situation has been more complicated after officials issued multiple papers to decrease leverage and curb risky behavior.

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While many are apprehensive about the ongoing financial “storm”, experts predicted the financial regulations would eventually bring a healthier market to the public, but asking for more transparency at the same time.

Are the financial regulations too heavy?

The Chinese government has been working on various efforts to contain financial systemic risk, including the tightening of regulations on shadow banking activities and closing of “zombie” stated-owned enterprises (SOEs).

When some argued that the current financial regulations would result in a credit crunch, Adjunct Professor Dai Xianfeng at Renmin University said that there would be no credit crunch, but “credit tightening” for sure.

“For sure, it’s going to lead to a credit tightening. Credit crunch, by definition, is a lack of credit availability, regardless of price, meaning even if you are willing to pay a high price, you still cannot get a credit. That happened before, but very rarely,” Dai said.

Richard Xu, the chief China financial sector analyst for Morgan Stanley, also believes a credit crunch will not happen.

Xu said that because the goal of financial regulation is not to “ban the credit, but for more transparency and improve efficiency.”

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So, he argued the regulations would be more visible with 70 percent cleanup still on the way, aimed at increasing market transparency; but less visible when put into force, trying not to affect markets too much.

Likely the proof of experts’ words, China's central bank said earlier it would boost coordination among different financial sectors and stabilize market expectations.

Although officials said the bank would keep liquidity stable as well, experts pointed out that tighter liquidity in 2017 would be in accordance with expectation.

Nevertheless, the financial sector is filled with hope – the financial system possibly will be healthier after cleaning up the shadow banking system.

Where will the financial regulations go?

Other “black news” has caused a stir in China’s financial sector -- the well-known credit rating agency Moody's Investors Service recently downgraded China's credit scores on its concerns about the country's potential rising debt and slowing growth.

Even the Chinese Ministry of Finance said the agency used an inappropriate way to assess the economic risks facing Beijing, and anxiousness hung over investors. That was because investment decisions rely heavily on the scores from rating agencies.

But this time the downgrade was not “relevant”, according to Dai, “because there are not many foreign investors in China’s bond.”

Yet Xu admitted that the downgrade might reflect some long-term concerns on China’s credit issues, probably due to rising leverage in China and some of the reduced transparency within China’s financial system, which overshadowed some improvements that we have seen in recent years as well, but “not exactly to the point.”

“That’s not entirely their fault. There are 15-20 percent credits that are not transparent. People don’t know where they went. From my perspective, China has some work to do. But, some of the risks were probably overdone,” Xu elaborated.

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As for the future, Xu underscored transparency again by saying “the key issue is how the investors figure out the repayment capability if you don’t have transparency.”

And Dai expected that China’s financial regulations would move towards objectives-based model with macro-prudential regulations, micro-prudential regulations and consumer protections.

“I think that is the way to go. But what is going to happen, let’s see,” Dai told CGTN.