Where Is The Leverage? What Are The Risks? ——Re-discussing The Creation Of Financial Leverage (Haitong Macroeconomics Jiang Chao, Liang Zhonghua)

Where is the leverage? What are the risks? ——Re-discussing the creation of financial leverage

Summary:

Everyone is talking about financial deleveraging and risk prevention, but where is the leverage? What exactly does risk mean? Faced with the problems caused by the rapid expansion of small and medium-sized banks, are banks too profit-seeking, or are supervision not strict enough? What is the core of banking supervision and what impact will it have? In order to clarify these issues, we might as well start with the bank's balance sheet and first look at what the bank's assets are allocated.

What did you buy on the bank asset side? In the table: Non-standard bonds exceed loans. Compared with large banks, small and medium-sized banks have limited loan allocation, with their proportion falling from 69% in 2010 to 48% in the third quarter of last year; at the same time, they have increased their allocation of bonds and non-standard assets, and the proportion of these two types of assets in capital utilization has dropped from 12% dropped to 12%. It was less than 17% in 2008 and has soared to 33% now. The bonds and non-standard assets of banks such as Guiyang, Nanjing, Industrial Bank, and Shanghai are more than 1.5 times the loans, and the bonds and non-standard assets of banks such as Ningbo, Hangzhou, and Jiangsu are also more than 1 times the loans. Off-balance sheet: Risk appetite is relatively high. According to data from the Financial Management Industry Association, 40% of bank financial management funds are allocated in bonds, but mainly credit bonds; although the proportion of non-standard assets in financial management allocation has declined due to regulatory influence in recent years, it is still 16%; Recently 10% of financial management funds are allocated in equity assets. Therefore, driven by high liability costs, banks' risk appetite when managing off-balance sheet financial funds is significantly higher than that of self-operated funds.

Where is the leverage? What are the risks? If funds raised from wealth management and certificates of deposit are invested directly in short-term bonds, banks may lose money. So how do banks achieve profitability? Term mismatches and leverage increase liquidity risk. Banks usually raise funds through certificates of deposit and financial management with short maturities, but the bonds and non-standard assets they allocate have longer maturities. The first maturity mismatch is achieved through short-term liabilities and long-term investments. When allocating assets, leverage can be further increased through pledged repurchases. Behind every leverage operation, there is a maturity mismatch, so the additional income mainly comes from the maturity spread. Such operations have led to increasing reliance on short-term funding by banks and non-bank institutions. Once the central bank tightens slightly, the financial system is prone to capital shortages or even money shortages. Investments become more aggressive and credit risk increases. Improving investment risk appetite is another source of increased returns for banks. On the one hand, banks and non-bank institutions are more active in investing in the bond market, especially financial funds that mainly allocate credit bonds or even mid- and low-grade bonds; on the other hand, new non-standard investments have been added to the table, including Industrial Bank and Bank of Nanjing , Shanghai Pudong Development Bank, Bank of Shanghai, etc., have a very high allocation of non-standard assets. In addition, the banking industry has penetrated into the real estate sector through loans, non-standard and other channels, increasing systemic risks to the entire economy.

Banking supervision, a game of “hide and seek”? Banks naturally love leverage! We have already introduced in the previous topic that banks are essentially an industry that relies on leverage to make profits. Therefore, as long as the interest rate differential exists, maximizing the size of assets and liabilities is the best choice. Therefore, the key to bank supervision is to control banks' impulse to increase leverage. In order to increase leverage and expand scale, banks have been playing hide and seek with supervision. Take non-standard investment supervision as an example. Banks have successively made non-standard investments through wealth management, interbank assets, accounts receivable and other methods. Channels gradually shifted from trusts to securities firms, asset management, fund subsidiaries, etc., all in order to cope with regulatory assessments. Regulation is tightening again, and leverage is key. The core of bank supervision is the capital adequacy ratio, which is the ratio of a bank's own capital to its risk-weighted assets, which is actually the bank's leverage ratio. For banks, they can either increase capital by issuing additional shares, control the growth rate of scale, or even reduce the scale of on- and off-balance sheet assets.

The currency cannot be loose, and turbulence is inevitable! In the short term, it will be difficult to relax monetary policy. From the perspective of the financial leverage formation chain, the central bank has continued to provide low-cost short-term funds in the past two years, which has indirectly promoted the trend of banks and non-bank institutions increasing leverage through maturity mismatch. Therefore, not only will the central bank not relax its policy in the short term, but when financial institutions actively deleverage and funds are loosened, they may also withdraw liquidity to prevent a comeback of leverage. The unrest continues, so the best strategy is to be careful! In the early stage, the central bank locked short positions, relaxed long positions, and raised financing rates, which directly increased the leverage cost of investments by banks and non-bank institutions, resulting in a shock correction in bond investment, which requires continuous repurchases to maintain; and the recent policy supervision of the China Banking Regulatory Commission may directly regulate, Even if the scale is reduced, banks will start to redeem outsourced funds, and asset selling pressure may even trigger a stampede. Therefore, in the short term, turbulence will continue and the best policy is to remain cautious.

text:

Since the fourth quarter of last year, the “voice” of financial deleveraging and risk prevention has become louder and louder, and has gradually transformed into policy actions that affect market trends. Everyone is talking about financial deleveraging, but where is the leverage? What exactly does risk mean? Faced with the problems caused by the rapid expansion of small and medium-sized banks, are banks too "profit-seeking" or supervision is not strict enough? What is the core of future banking supervision and what impact will it have?

We published "How is Financial Leverage Created?" 》 March 13, "This article mainly discusses the current situation and risks of the expansion of small and medium-sized banks from the liability side. In order to clarify the above issues, we might as well start with the bank's balance sheet and take a look at how the bank's assets are allocated.

1. What assets did the bank purchase? 1.1 In the table: non-standard bonds exceed loans

In terms of scale, small and medium-sized banks already account for half of my country's banking industry. Since 2010, the asset growth rate of small and medium-sized banks has basically remained above 20%. Especially in the past 15 years, the growth rate has accelerated again, while the asset growth rate of large banks has been around 10%. Therefore, the internal structure of my country's banking industry has undergone tremendous changes. The proportion of assets of large banks fell from 68% in 2010 to 52% at the end of the third quarter of last year, while the proportion of assets of small and medium-sized banks increased from 1/3. to nearly 50%.

Compared with large banks, small and medium-sized banks have limited loan allocations. In recent years, the loan scale of small and medium-sized banks has also expanded rapidly, but the proportion of loans in total assets has continued to decline. From the perspective of credit balance sheets, the proportion of loans of large banks to total funds used has basically remained stable at around 57%; while the proportion of loans of small and medium-sized banks dropped from 69% in 2010 to 48% in the third quarter of last year. %. This shows that the growth rate of loan allocation of small and medium-sized banks is much slower than the growth rate of total assets. This can also be seen from the ratio of listed bank loans to total assets. The loan allocation weight of Industrial and Peasant China Construction is basically maintained at around 50%. Among them, Bank of Guiyang and Bank of Nanjing accounted for less than 30%, and Bank of Shanghai, Industrial Bank, and Bank of Ningbo accounted for less than 35%.

So what are small and medium-sized banks planning? Give priority to bonds and non-standard products! We know that banks' self-operated funds can mainly only allocate claims, and if the mainstream claims are slightly broken down, they only include three major categories - loans, bonds and non-standard claims. Among them, non-standardization mainly refers to indirect lending by banks in order to bypass supervision and assessment. model. While the proportion of loan allocation has declined, small and medium-sized banks have significantly increased their allocation of bonds and non-standard assets. The proportion of these two types of assets in total fund utilization has soared from less than 17% in 2012 to 33% currently. In the past two years, the securities and investments of small and medium-sized banks have basically maintained an annual growth rate of about 10 trillion.

After the issuance of Document No. 127 regulating non-standard interbank investments in 2014, non-standard assets were gradually transferred from the "financial assets purchased under resale agreements" account on bank balance sheets to the "investment receivable" account. The proportion of accounts receivable investment in the total assets of listed small and medium-sized banks has rapidly increased from less than 1% to 18.4% at the end of the third quarter of last year, which also shows the preference of small and medium-sized banks for non-standard assets.

Some banks allocate far more to bonds and non-standard assets than to loans. If we add up the trading, available-for-sale, held-to-maturity financial assets and receivables investments in the balance sheet to estimate the size of bonds and non-standard allocations, we find that Bank of Guiyang, Bank of Nanjing, Industrial Bank , Bank of Shanghai and other banks' bonds and non-standard assets are all more than 1.5 times of loans, Bank of Ningbo, Bank of Hangzhou, Bank of Jiangsu are also more than 1 times.

1.2 Off-balance sheet: Risk appetite is relatively high

In recent years, the scale of off-balance sheet financial management has expanded rapidly. Wealth management products are an important tool for banks to compete for "liability" resources, and they also help small and medium-sized banks expand off-balance sheet. We predict that by the end of 2016, the banking industry's financial management scale will be around 30 trillion yuan, and will increase by 15 trillion yuan within two years. Among them, capital-guaranteed financial management included on the balance sheet is relatively stable, and off-balance sheet financial management may be 23 trillion, an increase of 13 trillion from two years ago. The issuance scale of wealth management products by small and medium-sized banks is much higher than that of large banks, and their proportion has further increased from 58% in early 2015 to more than 66%.

Banks have significantly higher risk appetite when allocating financial assets. Data from the Financial Management Association shows that as of the middle of last year, 40% of bank financial management funds were allocated to bonds, but mainly credit bonds: there are far more interest rate bonds than credit bonds on the market, but the financial management funds allocated to interest rate bonds are not enough for credit bonds. 1/4. Although the proportion of non-standard assets affected by regulation in financial management allocation has been declining in recent years, it is still 16%. In addition, nearly 10% of financial management funds are allocated in equity assets. Therefore, overall, driven by high liability costs, the risk appetite of off-balance sheet financial funds managed by banks is significantly higher than that of self-operated funds.

2. Where is the leverage? What are the risks?

First we might as well look at a phenomenon. Compare the interest rates on the bank's assets and liabilities. Both the issuance interest rate of on-balance sheet interbank certificates of deposit and the expected yield when off-balance sheet financial products are issued may be higher than the yield of bond market products. Higher: The 3-month certificate of deposit interest rate of joint-stock banks is basically the same as the 3-year AAA corporate bond yield; the expected 3-month financial management yield rate released by it is higher than the 15-16 3-year AAA yield rate. Corporate bond yields are more than 100BP higher. Therefore, if a bank uses funds raised from certificates of deposit or wealth management to directly invest in high-grade bonds, the bank may lose money. So how do banks use high-cost funds to achieve profitability?

2.1 Term mismatch and leverage increase liquidity risk

In recent years, among the important forms of bank liabilities, whether they are certificates of deposit or financial products, the terms are very short, mainly within 6 months. From an asset perspective, the duration of non-standard assets is very long. As a result, banks achieved a maturity mismatch between short-term liabilities and long-term investments for the first time. The advantage of this maturity mismatch is that in theory, the longer the maturity, the higher the yield. As a result, the cost of financial management may be higher than the income from bonds and non-standard investments in the short term. But if the product can run on a rolling basis, in the long run, banks can still earn profits because the duration of the allocated bonds and non-standard assets is longer than the cost of financial management.

In fact, banks raising funds through deposit certificate financing is equivalent to increasing leverage, and in order to increase returns when allocating assets, leverage will be further increased. When banks and non-bank institutions that undertake outsourcing invest in bond market products, they usually use leverage operations such as continuous pledged repurchase to amplify investment returns. As a result, the volume of inter-bank pledged repurchase transactions has surged from less than 500 billion in the early days to more than 2 trillion in the past two years, reaching a peak of 3 trillion.

When the leverage was increased for the second time, banks and non-bank institutions engaged in a second maturity mismatch, increasing risks. Pledge-type repurchase operations carried out by banks and non-bank institutions are leveraged and have short maturities. For certificates of deposit and financial management, banks need to update every three to six months, while for pledged repos, banks and non-bank institutions may need to update every day. Since the central bank and the China Banking Regulatory Commission supervise and evaluate bank assets and liabilities, this step of increasing leverage and maturity mismatch is mainly concentrated in non-bank institutions. So in the final analysis, what banks earn through two leverage operations is the term spread caused by term mismatch.

But here comes the problem. Maturity mismatch entails liquidity risk. The greater the mismatch, the greater the risk. Although a major source of profitability in the banking industry is taking on liquidity risk and earning the spread through maturity mismatches. Even traditional deposit and loan businesses have maturity mismatches. But the problem is that the worse the maturity mismatch, the greater the short-term risks faced by banks and non-bank institutions. The greater the reliance on end-to-end funding, the more fragile the entire financial system becomes.

In the past, the central bank continued to provide cheap funds and guarantee funds, and everyone could live and work in peace and contentment. But once the central bank tightens slightly, the financial system is prone to capital shortages and even silver shortages. Moreover, once short-term funding is disturbed, it may trigger bank redemptions and asset sales, leading to significant fluctuations in asset prices. In serious cases, it may even trigger a stampede, exacerbating systemic risks in the financial market.

2.2 Investment becomes more aggressive and credit risk increases

Another way banks can improve returns is by increasing their investment risk appetite, leading to an increase in the credit risk they bear. On the one hand, banks and non-bank financial institutions have increased their investment in the bond market. In particular, financial management funds not only mainly allocate credit bonds, but also hold large amounts of mid- to low-grade bonds in pursuit of high returns.

On the other hand, although the proportion of non-standard investments in banks' off-balance sheet financial management has declined since the promulgation of the "No. 1 Document". Document No. 8 shows that in 2013, non-standard investments among on-balance sheet investments increased. Under normal circumstances, banks will include non-standard assets in accounts receivable investment accounts. If measured according to this caliber, Industrial Bank's non-standard assets have exceeded loans, and the non-standard asset allocations of Bank of Nanjing, Shanghai Pudong Development Bank, Bank of Shanghai, Guiyang Bank and Minsheng Bank are also relatively high. Non-standard assets mainly provide financing support for local financing platforms, real estate and other enterprises, and banks bear higher credit risks.

In addition, my country's current high housing prices contain many bubble elements, and the banking industry has penetrated into the real estate field through loans, non-standard and other channels. Once the real estate market risk breaks out, the banking industry will be the first to bear the brunt, and the systemic risk of the entire economy continues to rise.

3. Is banking supervision a game of “hide and seek”?

Banks naturally love leverage! We have already introduced in the previous topic that banks are essentially an industry that relies on leverage to make profits and have very little capital. The “left hand” increases liabilities by absorbing deposits, issuing bonds, and issuing financial products, and the “right hand” increases asset allocation, earning the “price difference” in the middle. Therefore, as long as the interest rate differential exists, maximizing the size of assets and liabilities is the best choice to maximize profits. Moreover, due to the moral hazard problem of "too big to fail" in the banking industry, during the period of financial liberalization, domestic and foreign banks always tend to seize opportunities, increase risk appetite, and expand the scale of assets and liabilities. Therefore, the key to bank supervision is to control banks' impulse to increase leverage.

In order to increase leverage, expand scale, and increase profits, banks have been playing hide and seek with supervision. Take non-standard investment supervision as an example. In 2013, “Document No. 8” restricted non-standard investments of financial management funds, and banks turned to interbank funds one after another. In 2014, "Document No. 127" regulated non-standard investments between banks. Assets continue to shift from buy-and-resale accounts on bank balance sheets to accounts receivable investment accounts. Affected by regulatory changes, non-standard investment channels have gradually shifted from trusts to brokerage asset management, fund subsidiaries, etc. Take outsourcing investment, which has become very popular in the past two years, as an example. One of the important purposes of banks outsourcing funds is to increase leverage, and another purpose is to invest in the bond market for tax avoidance and arbitrage. In fact, it is all in response to supervision and assessment.

Regulation is tightening again, and leverage is key. If the liberalization of domestic interest rates in the past few years has brought about a wave of financial liberalization and the rapid expansion of assets and liabilities of small and medium-sized banks, which has brought certain risks, then starting from the fourth quarter of last year, the tone of macroeconomic policies shifted to prevention. risk, which also means that financial industry supervision will be stricter. The core of bank supervision is the capital adequacy ratio, which is the ratio of a bank's own capital to its risk-weighted assets, which is actually the bank's leverage ratio. Therefore, whether it is limiting the growth of certificates of deposit on the liability side, or controlling the expansion speed on the asset side, in the final analysis, it is to control bank leverage ratios. For banks, they can either increase capital through stocks, control the growth rate of scale, or even reduce the scale of on- and off-balance sheet assets to improve operational stability.

4. Currency cannot be loose, turbulence is inevitable!

In the short term, it will be difficult to relax monetary policy. Although inflation has ended, the economy remains stable, with GDP growing by 6.9% year-on-year in the first quarter. Considering the tasks of financial deleveraging and risk prevention, it is still very difficult to relax monetary policy. From the perspective of the financial leverage chain, the central bank has continued to provide low-cost short-term funds in the past two years to maintain financial stability. In fact, it indirectly encourages banks and non-banks to increase leverage through maturity mismatches. Therefore, not only will the central bank not relax its policy in the short term, but when financial institutions actively deleverage and funds are loosened, they may also withdraw liquidity to prevent a comeback of leverage. However, judging from recent statements, the central bank does not want regulatory policies to cause significant market fluctuations. Therefore, the central bank will still take care of it when funds are tight.

The unrest continues, so the best strategy is to be careful! Whether it is the previous increase in short-term policy interest rates by the central bank or the recent regulatory documents issued by the China Banking Regulatory Commission, the core is deleveraging. To achieve this goal, the liability side can strengthen the management of the issuance of certificates of deposit; the asset side can limit the speed of scale expansion or even reduce the scale through MPA assessment; the rise in capital costs will also help curb the impulse of financial institutions to increase leverage due to maturity mismatch. From a practical point of view, in the early stage, the central bank locked short-term loans, issued long-term loans, and raised financing rates, which directly increased the leverage cost of investments by banks and non-bank institutions, resulting in the impact and adjustment of bond investments that required continuous repurchases to maintain; and recently, the China Banking Regulatory Commission Policy supervision may start directly from controlling or even reducing the scale. Banks will begin to redeem outsourced funds, and asset selling pressure may even trigger a stampede. Therefore, in the short term, turbulence will continue and the best policy is to remain cautious.

标签： #Banks #Bonds #Investments #Financial Leverage #Finance