Asset Management Association of China (AMAC) released 2Q17 AUM data forvarious asset management institutions and we noticed that AUM of mutualfund subsidiaries, which is a major shadow banking channel continued todecline. Mutual fund subsidiaries’ AUM started to decline from 4Q16 afterregulators imposed tighter capital rules and was Rmb8.59trn as of 2Q17, downRmb1.32trn/13% qoq or 22% yoy. In addition, brokers’ AUM also saw aRmb674bn drop qoq in 2Q17 to Rmb18.1trn, due to less shadow bankingbusiness – brokers’ directional AMP AUM down Rmb619bn qoq toRmb15.4trn.    (DB view) This is another evidence that financial deleveraging is taking effects.    PBOC also reported that banks’ receivable investments (major accounting itemfor shadow credit) shrank by Rmb866bn qoq in 2Q17 to 21.36trn. Financialdeleveraging so far has already made progress by cutting off excess nonproductiveleverage, shortening the financing chains, and trimming shadowbanking (financing chain multiple dropped from 1.85x in 1Q17 to 1.01x in2Q17). Meanwhile, financial sector support to the real economy remainsresilient, as suggested by a pick-up in corporate long-term loans. We expectfinancial deleveraging to continue, resulting in elevated market rates andconsistent regulatory tightening. This should drive up NIM for big banks andboost loan growth for them, while smaller banks could be forced to slow downasset expansion due to capital and regulatory pressure. We expect China’sfinancial deleveraging campaign to be orderly before the leadership transition.    Please refer to our report - Time to accumulate big banks.    PBOC released its 2017 regional financial development report recently,highlighting the asset/liability mix change in regional local banks during 2012-16, and the analysis of supply-side reform. PBOC monitored local banks’financial structure by analyzing 193 banks’ financial statement, whose funding sources have diverged in the past 5 years. The weighting of deposit graduallydeclined from 73.7% in 2012 to 71.1% in 2016 as banks were keen on liftingup wholesale funding, ie interbank CDs and interbank borrowing. InterbankCDs and interbank borrowing represented 28.4% of local banks’ total liability in2016 from 22.6% in 2012. NIM narrowed in the past five years from interestrate cut and rising funding pressure post interest rate liberalization. On assetside, the usage of fund was more diversified. Local banks have allocated moreassets on interbank, non-standard investments and off balance sheet wealthmanagement products. As of 2016, loan/asset dropped by 5.5ppt from 2012,while investment/asset has increased by 13.7ppt. As a result, some banks’revenue contribution from financial market surpassed traditional retail orcorporate lending, ie 9 banks in Sichuan Province saw above 50% revenuefrom financial market in 2016. Meanwhile, local banks’ off-balance sheetWMPs also grew rapidly in 2012-16 with CAGR at 60.2%, 40.6% higher thanasset CAGR in the same period. In 2016, retail and institutional WMPsrepresented 54.6%/45.4% funding source respectively. For investment type,more than 53% off-BS WMPs were allocated to bond investment.    PBOC also mentioned supply-side reform has achieved short-term target. In2016, coal and steel industry cut 290mn ton/65mn ton capacity respectively. In2017, 26 coal mines were closed and c11.3mn ton low-quality capacity wascut. For cement industry, around 50mn ton capacity was cut in 2015-16;industry centralization has been lifted up by 5ppt in 2016 via merger andacquisition. For shipbuilding, industry centralization also increased by 3.5ppt in2016; orders to top 10 players accounted for 74.7% national orders, up 4.1pptyoy. As of end-2016, financial institutions’ on- and off-BS lending exposure tosteel, coal industries declined by 2.2%/0.6% yoy respectively; meanwhile, theNPL ratios of steel/coal were at 2.6%/3.6% in 2016. Utilization rate in steel,alumni and cement came at 71.2%/83.3%/75.2% in 2016, up 4.2/4.9/1.4pptyoy.    Furthermore, PBOC said in the report that it may consider to includesystematic important internet finance products/institutions into MPAregulation.

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