BEIJING - The growth of China's asset-backed securities (ABS) market will provide greater operational flexibility for banks' liquidity and capital management, provided securitized assets are sufficiently transferred outside of the banking system, according to a report released by Fitch Ratings on Tuesday.

The government has placed increasing emphasis on asset securitization to free up idle assets within the banking system.

In April, the PBOC announced that it would no longer require regulatory approval to issue ABS while the State Council approved an additional quota of 500 billion yuan (around $80 billion) for the ABS trial program in mid May.

Latest figures from the People's Bank of China (PBOC) showed outstanding ABS in China was 300 billion yuan as of end of April, and Fitch believes there is potential for significant further expansion this year.

Fitch expected non-bank financial institutions to play a bigger role in the asset securitization market, while in the medium term they are not likely to overturn the dominant position held by the banks.

Formal securitization provides an additional source of liquidity for banks and the potential for better asset-liability management, since it can release bank capital to stimulate lending to the real economy.

However, Fitch noted that it remains to be seen if credit risks will be sufficiently transferred outside the banking system.

The potential benefits may be limited if the norm is for exposures to be supported - for example, via forbearance - and banks end up investing in other banks' ABS, according to the report.

Meanwhile, the Chinese government is encouraging banks to use the proceeds from their securitization to support particular areas, including water resource projects, slum clearance and housing renovation as well as railway construction in central and western China.

Fitch noted that large-scale state-directed lending might lead to over-investment and capital mis-allocation, and that the freed-up capital from securitization could be easily consumed by a subsequent expansion in assets.