2010 was a tough year for China’s financial regulators. While on the face of it banks sharply reduced their lending, in line with Beijing’s decision to call an end to economic stimulus spending, the reality was banks lent just as much as the year before but hid a lot of it off-balance-sheet. Though the China Banking Regulatory Commission has been trying to bring wayward lending back onto the books, the genie is out of the bottle. And in a country where new loan data is one of the key determinants of monetary policy, that’s a real problem. Now moves are being made to do something about it. In an essay posted on its Web site Thursday, the People’s Bank of China proposed a radical overhaul of how monetary policy wonks look at the economy. “New yuan loan data no longer actually reflects the extent of financing in the real economy,” said the essay ( in Chinese ), authored by Sheng Songcheng, director of the PBOC’s Survey and Statistics Department. Sheng proposes a new formula that includes more than just loan data. “That will help avoid overly focusing on the size of loans and needing to play whack-a-mole, where one problem pops up while you’re dealing with another, such as banks using off-balance sheet lending to avoid credit limits,” Sheng wrote. While banks formally lent 7.95 trillion yuan, or roughly $1.2 trillion, in loans last year, according to the essay, the use of entrustment loans (where-by banks match-make lenders and borrowers and take a fee for their pains) and bank acceptance bills (a type of bank guarantee) meant off-balance-sheet lending inflated banks’ credit creation by a further 3.47 trillion yuan. An Fitch Ratings report issued in December estimated “credit leakage” from the banking sector at more than 3 trillion yuan . The new formula to calculate what the PBOC has termed “social financing” adds yuan loans to foreign currency loans, entrustment loans, trust loans, bank acceptance bills, corporate bonds, funds raised by share sales of non-financial companies, insurance payouts, insurance companies’ investment properties and “others,” and leaves open the option of including private equity and hedge funds in the future as those sectors mature. According to the essay, focusing on new loan data once made sense in an economy where the banks were by and large the only source of financing, but the development of China’s capital markets over the last nine years now means at the end of last year loans accounted for less than 60% of all financing. Despite the fairly holistic attempt to paint a snapshot of actual fundraising in the economy, there’s still one notable emission from the formula: China’s informal lending sector. China’s banks have long neglected lending to entrepreneurs and small firms. Beijing has been trying to redress the problem in recent years by launching a raft of small-scale financial institutions to plug the gap and by encouraging the major commercial banks to set up SME funding units. Still, there is a major unregulated cottage industry for loans, the relative size of which varies from year to year: According to some estimates informal lending was about a third of the size of total new banks loans in 2007, a year when monetary conditions were significantly tighter than the last couple of years. With the banks sloshing money around over the last couple of years, the informal lending networks, loans between family and friends, and underground banks have been relatively less important. And Beijing may now feel that its efforts to encourage formal institutions to extend credit to smaller firms is also reducing the overall importance of informal lending. But if monetary policy does start to tighten meaningfully this year, it Beijing might find its new indicator comes up short. –Dinny McMahon

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Beijing Goes on the Hunt for Hidden Lending

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