2 January 2018BanksChinese banks - 2018 OutlookPage 2 Deutsche Bank AG/Hong Kong Financial deleveraging:market rate hikes, newcommittee, tighterregulationsContaining financial risks at top of government’s agendaChina has de-emphasized the growth target and made containing financialrisks a top priority. The Central Economic Work Conference, concluded on 20December 2017, has listed three policy priorities in 2018-2020: containing andresolving major financial risks, poverty reduction and environmental protection.This is consistent with signals from the 19th party congress, wherepolicymakers emphasized growth quality over quantity. The tighter policy bias is warranted by the still-elevated leverage in China’sfinancial sector and real economy. In the financial sector, M2 balanceaccounts for 207% of GDP currently, and the credit-to-deposit ratio in theChina banking system stands at 118% (Figure 1). In the real economy, weestimate that total non-financial sector debt made up 276% of GDP as ofSeptember 2017, with local governments and SOEs highly levered (Figure 2).While the pace of leverage build-up has slowed due to recent financialdeleveraging efforts, the elevated leverage suggests that we cannot safelyassume that the risks have disappeared. Meanwhile, the tolerance level of theChinese government has not been reached. Economic growth has surprised onthe upside and employment conditions remain resilient. Figure 1: Leverage in China’s financial sector has stayed elevated, although the build-up of leverage has slowed210% 207% 140% 150% 160% 170% 180% 190% 200% 210% 220%M2 / GDP 70.0% 80.0% 90.0% 100.0% 110.0% 120.0% 130.0%Leverage in China banking system Credit-to-deposit ratio (excl. NBFI deposits) - 3-m rolling Theoritical credit to deposit ratio (= 1 - reserve ratio) Largelyin line Source: Deutsche Bank estimates, PBOC, CBRC, WIND Note: Credit-to-deposit ratio is calculated as total banking credit (including loans, bond investment and shadow banking) as a percentage of total deposit balance, adjusted for off-balance-sheet WMP on bothnumerator and denominator. 2 January 2018BanksChinese banks - 2018 OutlookDeutsche Bank AG/Hong Kong Page 3 Figure 2: Leverage of real economy is still on the rise, but at a slower pace44 46 46 46 48 54 63 64 60 63 70 70 66 60 55 51 50 65 68 67 62 57 57 57 53 52 51 49 51 59 69 70 7684 86 92 95 96 96 9 10 11 11 1315 18 19 19 2023 25 24 23 2221 2231 34 35 32 34 39 43 46 41 38 36 32 40 38 35 3942 47 5458 58 572 2 3 33 478 9 11 12 14 16 17 17 17 19 18 2331 32 3337 3941 47 49 502 2 2 2 2 2 2 2 4 4 568 9 11 11 1517 16 16 14 18 16 1716 15 1516 1618 18 18 181 2 3 45 6 7 8 911 13 14 15 16 17 1726 26 2729 323744 5453 5453 57 58 58 61 7082 85 81 85 96 98 95 89 85 82 84113 123 127 123 125136 146 146 140 138 138 134165 180 178193 211225248272 275 2760 50 100 150 200 250 300%China's debt-to-GDP ratio during 1980--3Q17 Local governments Central government Households Private enterprises SOEs +141ppt in9years Source: Deutsche Bank estimates, PBOC, CBRC, CIRC, SAFE, NBS, MOF, CEIC, WIND, Chinabond, Trustee Association of China, SAC, HKMA, media reports Note: 1) We have included loans, bonds, shadow banking and offshore credit; 2) We have eliminated the overlapping between different financing channels; 3) We classify LGFV debt into local government debts.As such, we expect China’s financial deleveraging campaign to be carried onin coming years. Over the past year, the financial regulators have lifted marketrates and rolled out plenty of new regulations. We highlight these measures inthe below diagram and have also elaborated on it in previous reports (Financialdeleveraging – Rising funding pressure, Impact Series I, II, III, and IV). Lookingahead, under the “dual-pillar” monetary framework discussed by President Xiat the party congress, we expect a combination of neutralized monetary policyand tightening macro-prudential policy. We will elaborate more in thefollowing sections of this report. Figure 3: Summary of recent financial deleveraging effortsOther assets (6%) Credit to interbank and PBOC (14%) Credit to NBFIs (12%) Cash & deposits with PBOC (11%) Credit to corporate (36%) Credit to household (14%) Credit to government (7%) Assets (% of total) Liabilities & equity (% of total) Corporate & retail deposits (65%) Borrowing from interbank and interbank CDs (10%) Borrowing from NBFIs (7%) Bond issuance (7%) Borrowing from PBOC (4%) Other liabilities (8%) Measures targeting liabilitiesside:-Money market hikes(OMO/MLF/SLF) -Lengthened MLF duration -NCDs to be included in theinterbank funding (1Q18) China banking system The Guidelineon AssetManagementBusiness (Dec2017) Comprehensiveself-assessmentrequired byCBRC, so called3-3-4 series(April 2017) Liquidity RiskManagementGuideline(Dec 2017) Measures targeting assetsside:-Shadow bankingtightening by CBRC (April2017) -Channel businessestightening by CSRC(1H17) -New rules on bank-trustcooperation (Dec 2017) -Broad credit requirementin MPA to cap banks’asset growth (1Q17) Measurestargeting ongeneralbusinesses:Establishmentof FinancialStability andDevelopmentCommittee(Nov 2017) Source: Deutsche Bank, CBRC, PBOC, Caixin2 January 2018BanksChinese banks - 2018 OutlookPage 4 Deutsche Bank AG/Hong Kong What are the most impactful deleveraging measuresAmong these comprehensive financial deleveraging efforts, there have been acouple of important initiatives and regulations, which we believe will form atighter regulatory environment, to reshape the landscape of shadow bankingand lower systemic financial risks over the longer term. The most important change – “Super-regulator” China announced that it will set up a new and high-level committee, theFinancial Stability and Development Committee, during its fifth NationalFinancial Working Conference during 14-15 July 2017. This new committee isled by one of China’s vice premiers (currently led by Premier Ma Kai) and is seton top of the PBOC and other financial regulators. It is designed to be thecoordinating entity within the State Council on major issues related to financialstability and financial reform and development. According to news reports, itsmain responsibilities include 1) reviewing and approving major plans related tofinancial development and reforms; 2) coordinating among monetary policy,financial regulations, financial reforms, fiscal policy and industrial policies; 3)studying policies to contain systemic financial risks and ensure financialstability and 4) guiding local financial regulators. We see the establishment of this new committee as a crucial step tostrengthen China’s financial regulatory framework and lower systemic risks.In the past, one of the key drivers to proliferation of China’s shadow bankinghas been its fragmented regulatory framework, as there has been a lack ofsufficient communications and coordination among the four financialregulators. In some instances, there was even competition between regulators,leading to aggressive expansion in some asset management products. A newcommittee led by a more senior leader of government and set above existingregulators should help improve regulatory coordination and curb the regulatoryarbitrage of financial institutions by closing loopholes and reducing regulatorycompetition. In our view, this should contain growth and reduce the murkinessof China’s shadow banking system.Figure 4: China’s regulatory framework is shifting towards being more coordinated, as the new committee has beenset up on top of all current regulatorsCBRCCSRCCIRC Banks’ WMP(Rmb28tr) Trust plans (Rmb20tr) Brokers’ AMPs (Rmb18tr) Public mutual fund (Rmb10tr) Fund and fund subs’ AMPs (Rmb15tr) Private funds(Rmb9.5tr) Insurance investmentfunds(Rmb1.9tr) PBOC Monetary policyMacro-prudential assessment China’s regulatory framework on asset managementbusinesses (in the past) CBRCCSRCCIRC Banks’ WMP(Rmb28tr) Trust plans (Rmb20tr) Brokers’ AMPs (Rmb18tr) Public mutual fund (Rmb10tr) Fund and fund subs’ AMPs (Rmb15tr) Private funds(Rmb9.5tr) Insurance investmentfunds(Rmb1.9tr) PBOC Monetary policyMacro-prudential assessment China’s regulatory framework (at present) Financial Stability and Development Committee Source: Deutsche Bank, CBRC, CSRC, PBOC, CIRC 。。。。。。