Another 2008？

　　By expanding a pilot program for securitizing credit assets， could China‘s own subprime mortgage market be at risk？

　　The United States is home to a mature system of financial derivatives in which loans are packaged into securities and unleashed onto the market. These days， the practice is gaining momentum here in China.

　　At the State Council executive meeting hosted by Premier Li Keqiang on August 28， a decision was made to further expand the pilot program for securitizing credit assets， while strictly controlling risks. A major push factor behind the campaign may be the liquidity crunch in China’s banking sector at the end of June (for more information， please refer to issue No. 27).

　　Lu Zhengwei， chief economist of Industrial Bank Co. Ltd.， said the popularization of credit asset securitization will motivate China‘s financial industry to liquidize remnant assets and better distribute its financial resources， all the while shoring up the real economy. Besides， using new capital properly and revitalizing existing assets make up the core of Premier Li’s belief that the financial industry must be better used to support the real economy.

　　Start up

　　Credit asset securitization， though playing an important role in the developed world， is still in its infancy in China.

　　China started allowing credit asset securitization on an experimental basis in March 2005. A total of 11 domestic financial institutions issued asset-backed securities (ABS) products worth 66.78 billion yuan ($10.91 billion) between 2005 and 2008， according to the People‘s Bank of China (PBC)， the central bank.

　　Affected by the 2008 U.S. subprime mortgage crisis and the global financial crisis， the pilot program struck a reef in 2009. It was not resumed until 2011， when six financial institutions issued ABS products worth 22.85 billion yuan ($3.74 billion).

　　Thanks to the pilot program that has lasted for eight years， a basic system of credit asset securitization has been established， with the issuance and trading of ABS products running smoothly and the initiators and investors becoming increasingly diversified， said the PBC.

　　However， compared with the United States， China’s credit asset securitization is still in its preliminary stages. Statistics from some American financial institutions show that in the wake of the 2008 subprime crisis， the value of ABS products issued in the United States slumped from its peak of $2.9 trillion in 2006 to $1.5 trillion before the market began to recover gradually. The value of ABS products issued in 2012 reached $2.2 billion， up 26.9 percent year on year， accounting for 32.3 percent of bonds issued during the same period. The value of all existing ABS products stood at $9.9 trillion in 2012， making up 25.8 percent of existing bonds.

　　In stark contrast， at the end of March 2013， the value of existing ABS products in China was a mere 27.8 billion yuan ($4.54 billion)， while the value of deposited bonds was 26 trillion yuan ($4.25 trillion). Yuan-denominated loans reached 66 trillion yuan ($10.78 trillion).

　　Significance

　　According to the PBC， China‘s financial macro-controls are under great pressure， and monetary loans are increasing rapidly. The expansion of credit asset securitization is beneficial in four respects.

　　It will be conducive to restructuring credit assets， encouraging reforms in key sectors like railway and shipbuilding， and intensifying credit support to projects like government-subsidized housing.

　　Commercial banks will distribute their core capital in a more efficient way， and the capital market can better finance the real economy.

　　It will also push commercial banks to shift from an expansion-driven operation model， reduce financing costs and boost intermediate business income.

　　Finally， investors will be provided with more alternatives to distribute financial assets.

　　Lian Ping， chief economist of Bank of Communications， said that the expansion of the pilot program would enhance asset liquidity， for banks can resell loan assets to other investors and have more funds to inject into assets with higher rates of return. “With the credit asset securitization， the quality of bank assets will be improved， and fewer restrictions will be imposed on the assets-to-securities process. In this way， banks will face less pressures of replenishing capital，” Lian said.

　　Moreover， banks can earn non-interest income by reselling loan assets for themselves or on behalf of other financial institutions， which will improve revenues.

　　From a macro perspective， the lending quota after selling securitized assets can be granted to the weaker parts and key fields of the real economy， especially in small and micro-sized businesses， and in agriculture and infrastructure. By the end of July， the balance of yuan-denominated loans had amounted to 68.78 trillion yuan ($11.24 trillion)， two thirds of which， or 45.85 trillion yuan ($7.49 trillion)， could be securitized， Lian argued. Even securitizing a small portion can result in impressive yields.

　　Risk prevention

　　Credit asset securitization is a double-edged sword， just as the 2008 subprime crisis has shown. Zhao Xijun， a professor from Renmin University of China， holds that in the context of an economic slowdown， loans in some areas were faced with default risks. Therefore， identifying the quality of ABS products is key.

　　As to how to ensure China’s credit asset securitization would not incur a subprime crisis like in the United States， the PBC suggests including high-quality credit assets into the program.

　　Currently， credit assets that may undergo securitization include credit loans， guarantee loans， small and micro-sized business loans and auto loans.

　　The State Council executive meeting on August 28 also called for strict supervision of securitizing credit assets and that the functions and responsibilities of trust companies and accounting firms should further be made clear in this regard.

　　Wang Guogang， an expert from the Institute of Finance and Banking under the Chinese Academy of Social Sciences， said enterprises should be given enough freedom in choosing credit asset securitization as a financing channel， but he is worried that local governments may interfere in the process. Since the Central Government is trying to tighten the issuance of local bonds， local governments may resort to re-securitization to get new funds， which could further plague these governments， many of which are faced with crippling debt. Strict precautions should also be taken against excessive securitization； otherwise China could face a U.S.-style subprime mortgage crisis， said Wang.

　　Furthermore， the ability of enterprises to repay decides the quality of ABS products. Information about ABS products， such as gains and losses， defaults and risks， should be published regularly， said Wang.

　　“That way， investors can spot and guard against risks by analyzing the quality of ABS products as well as referring to the credit rating of issuers.”