China's burgeoning financial leasing companies are emerging as significant financial players. Their number has surged to 2,202 in 2014, from 80 in 2007, and total leasing assets increased to Rmb3.2 trillion from Rmb24 billion. The sector’s assets increased an average 55% in 2010-2014, thrice the rate at which banks grew (see chart). China is estimated to be the second-largest leasing market globally behind the US in terms of new business volume.
Why are they growing so quickly?
Rising market demand and a more supportive regulatory environment have fueled the growth. The China Banking Regulatory Commission (CBRC) has been granting financial leasing licenses to some large local banks since 2007. Also, the Ministry of Commerce (Mofcom) has lowered the entry barrier for foreign players, granting over 2,000 licenses to smaller players in the past decade.
Many banks and equipment manufacturers in China set up financial leasing subsidiaries to capture the growing demand for leases when domestic investments activities grew. Policy incentives, such as tax benefits, have also encouraged obligors to finance via financial leasing rather than bank borrowings.
The still-low market penetration suggests further growth potential. Indeed, we believe that financial leasing businesses associated with asset specialization, backed by favorable government policies and taxation, will continue to fuel market growth.
How are these companies classified and regulated?
Two types of companies operate in China's financial leasing sector: ones under the CBRC licenses and ones under the Mofcom licenses. Although they operate under different regulations, both types of companies have grown strongly over the past few years.
The financial leasing companies licensed by the CBRC are owned by local financial institutions, such as banks or asset-management companies. These companies are highly regulated by the CBRC and hold a financial institution license that allows them to borrow in the interbank market, which may provide cheap short-term funding. In comparison, the financial leasing companies licensed by the MofCom are lightly regulated with shareholders from more diverse backgrounds, including local manufacturers or foreign investors. These companies are treated as nonfinancial companies in the domestic credit market.
The CBRC supervises the financial leasing companies under its purview in a manner similar to how it supervises banks. These CBRC regulated entities typically are larger and are prudentially supervised with risk-based controls and limits. They have good access to interbank funding and bank borrowings, particular when the companies are part of a large banking group. Such funding gives their pricing a competitive edge against the other players. At the end of 2014, the CBRC regulated only 30 financial leasing companies out of the total 2,202 players in the industry, but they owned 41% of the sector's assets.
The Mofcom typically supervises financial leasing companies under its purview like corporate entities. These companies are generally smaller and have no access to interbank funding, which financial institutions usually have. That said, some niche players owned by large manufacturers may leverage on their corporate background and franchise and superior product knowledge to enhance customer relationships. These niche players are a small part of the total more than 2,000 MofCom-regulated players in the market, with 59% of the sector's total assets.
What key risks do they face?
Credit risk remains the major threat to this sector, in our opinion. China's slowing economic growth and already-high private debt have heightened asset-quality risks in many industries, and this would inevitably spill over to financial leasing companies as well. This heightened risk is particularly relevant if it relates to an industry that these financial lease companies have a specialized focus. In a financial lease, the lessors take the credit risk on lessees' principal and interest payment. Nevertheless, in the event of borrowers default, their ownership of these quality lease assets may provide good prospects for loss recovery.
We believe China’s financial leasing sector encounters higher industry risk than banks. This sector typically lacks funding access to the central bank and heavily relies on wholesale funding. Supervision and regulation on this industry are generally less comprehensive than that for banks, except for those under the CBRC's supervision. These financial leasing companies are also susceptible to business cycles, which may lead to volatile revenue. For the financial leasing companies that the CBRC regulates, the anchor would be a notch higher given that the supervision is the same as that for banks.
Is this growth going to continue?
'Yes. We expect China's financial leasing sector to grow much faster than its banks over the next two-to-three years. However, the annual rate of growth could be less than the previous 55%, given the higher base and the slowdown in China’s economy. More favorable government policy and ample liquidity in the domestic market would continue to offer industry players strong incentives to stay in this market. More resources, including capital, funding, and management, may continue to fuel the growth. The relatively low penetration rate of leasing activities in China also indicates great growth potential, albeit with greater risk in the current economic climate. According to White Clarke Group’s 2015 global leasing report, the penetration rate (as defined by the percentage of a nation’s annual leasing volume to its total fixed investment amounts in plant and equipment) in China was 3.1% in 2014, which is significantly lower than 40% in Australia, 31% in the UK, 22% in the US, 17% in Germany, and 9.8% in Japan.
Given financial leasing is one of the major channels to fund investment activities globally, we expect demand for financial leasing services in China to remain robust. The recent government announcement that it would speed up the development of the financial leasing segment shows China's commitment to support the growth in this industry through increasing policy support and resources for this market.
The author is Chris Lee, an associate director in the Financial Services practice at Standard & Poor's Ratings Services.