China's new regulations elevate major shareholder role in consumer finance

April 05, 2024 (MLN): China’s latest regulations targeting consumer finance companies signal the authorities' push to increase major shareholders' involvement in and support for their consumer finance subsidiaries, and are aligned with the regulatory direction for other types of entities under the National Administration of Financial Regulation (NAFR), says Fitch Ratings.

The stronger credit profiles of consumer finance companies would be positive for consumer finance asset-backed securities (ABS), for which the former serve as originators and servicers, as this will promote stronger servicing continuity.

The final regulations, released in March following a consultation paper in December last year, will take effect on 18 April.

The new rules impose stricter requirements on major shareholders, including mandating a minimum of 50% shareholding, slightly lower than the 51% for financial leasing companies and more stringent asset and revenue thresholds.

This is likely to drive more shareholding restructurings in the consumer financing sector, but we believe the regulator will allow a grace period for remediation.

Currently, 14 of the 31 licensed consumer finance companies have major shareholders that own stakes smaller than 50%, and some existing major shareholders fall short of the asset and revenue thresholds.

The new rules also strengthen the major shareholders' obligation to provide capital and liquidity support to consumer finance subsidiaries when necessary, indicating that the probability of parental support from major shareholders during times of stress will increase.

Such a requirement is common for companies supervised by the NAFR and suggests the regulator's intent to encourage stronger commitment from shareholders of financial institutions to mitigate risks.

However, similar to the financial leasing company rules, those for consumer finance companies do not specify a time period for support and the regulation has not been tested.

Fitch expects several consumer finance companies to receive capital injections in the coming years, as the new rules have increased the minimum registered capital for such companies to CNY1 billion, from CNY300 million, and introduced stricter leverage and liquidity requirements.

Currently, around one-third of existing companies have registered capital below the minimum requirement.

The higher capital bases should strengthen these companies’ capacity to absorb potential credit losses and we view the rules as positive for their standalone credit profiles.

Consumer finance companies will also need to bolster their risk management capabilities and reduce reliance on third-party guarantees, as the new rules cap the share of credit-enhanced loans at 50% of total loans.

These guarantees are usually provided by financing-guarantee or insurance companies, whose ability to fully absorb non-performing loans remains untested.

The 50% cap should help limit contagion to other parts of financial system and spur consumer finance companies to focus on borrowers with better credit quality.

The potential shareholding restructuring and persistent economic challenges will weigh on consumer-finance sector growth.

Issuance of consumer loan ABS by consumer finance companies reaccelerated in 2023, but we do not believe that this indicates a surge in overall consumer loan originations in the industry.

Rather, the growth was most likely because more consumer finance companies met the minimum five-year operating record requirement and received regulatory approval to issue ABS. Some consumer finance companies also relied more on ABS as a funding channel.

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