Will China bite the credit asset securitisation bullet?

China’s financial sector sent out a radical signal with two recent developments. Its biggest bank ICBC is attempting asset securitisation in the risky zone of non-performing assets and also expanding into corporate asset securitisation. In the non banking sector, Internet giant, Alibaba Group, has also launched 500 million renminbi of asset-backed securities.

In the first case of a domestic bank undertaking a non-performing asset securitisation step, ICBC launched the ‘Ningbo non-performing loan securitization project’. The product has a loan of 2.6 billion renminbi as its base asset and is divided into two grades of varying risks to be sold to investors. This is the first security product launched with no guarantee and no buy-back promise.

The Alibaba Group generated greater interest with its asset-backed securities launched using the special asset management plans (SAMPS). The securities are backed against short-term micro-loans that Alibaba Finance provided to clients on its e-commerce platforms, making it China’s first public securitisation of SME loans. The China Securities Regulatory Commission now allows securitisation by financial organizations under a RMB 5 billion quota. Although small, this financing serves as another funding alternative for millions of Chinese SMEs at a time when traditional sources of credit are under pressure. Alibaba has lent to 300,000 SMEs and its non-performing loan rate is 0.87 per cent.

ABS products

In August, China decided to expand a pilot programme for securitising credit assets in an effort to clean up vast amounts of bad debts. Now, high quality asset-backed securities (ABS) products can be traded on the stock exchange to provide more investment options for investors. The precondition is that risk would be strictly controlled and high risk assets will be excluded from the pilot programme.

China had experimented with ABS products in 2005, but went slow after the 2008-2009 financial crisis. It tried to relaunch the program in 2011, but caution halted any progress. The recent enthusiasm behind the present pilot campaign may be the liquidity crunch the domestic banking sector faced this year. Securitisation may motivate the financial industry to liquidize remnant assets and better distribute its financial resources, with the underlined intention of shoring up the ‘real economy.’

Securitisation is the process through which an issuer creates a financial instrument by combining other financial assets and then marketing different tiers of the repackaged instruments to investors. The process can encompass any type of asset — residential housing mortgage loan, commercial housing mortgage loan or medium and long term project loans - and is supposed to promote liquidity in the marketplace. Mortgage backed securities are usually the most popular. By combining mortgages into one large pool, the issuer can divide the large pool into smaller products based on individual mortgage’s inherent risk of default and then sell the smaller packages to investors.

China’s financial macro-controls are under great pressure, and monetary loans are increasing rapidly. The pilot program can enhance asset liquidity, as banks can now resell loan assets to other investors and have more funds to inject into assets with higher rates of return. Moreover, conservative Chinese lenders can earn non-interest income by reselling loan assets for themselves or on behalf of other financial institutions. This will help improve their revenues. Commercial banks can also distribute their core capital in a more efficient way, and the capital market can better finance the real economy.

Risk prevention

But credit asset securitisation is a double-edged sword, as the 2008 subprime mortgage crisis in the United States has shown. Although it is still in its infancy in China, policy-makers are cautious even about experimentation. In the context of China’s own economic slowdown, it is saddled with plenty of loans with high default risks. Therefore, identifying the quality of ABS products will remain the key. The People’s Bank of China has insisted that to prevent a subprime crisis like the US, only high-quality credit assets should be included in the program. Currently, credit assets that may undergo securitisation include credit loans, guarantee loans, small and micro-sized business loans and auto loans.

The big worry is that local governments may interfere in the process of choosing these asset products. Local governments, reeling under crippling debt, may end up resorting to re-securitisation to get new funds, which could further plague these governments and exacerbate the crisis. If China doesn’t take steps against excessive securitisation by local governments, it may well end up with a US-style subprime mortgage crisis.