Category Archives: Banking

Even The Ever-Optimistic IMF Frets Over China-US Trade Tensions

THE INTERNATIONAL MONETARY FUND has cut its forecast of China’s 2019 GDP growth by 0.2 percentage point to 6.2% because of the expected impact of tariffs imposed as a result of its trade dispute with the United States. In its newly published World Economic Outlook, the Fund also projects 6.6% growth for this year, down from 6.9% in 2017 as the policy measures to slow credit growth and deleverage the economy take effect.

However, the IMF expects China to apply domestic stabilisation measures that will boost growth in 2019 by 0.5 percentage points to offset the impact of the tariffs, which the Fund estimates to cut growth by 0.7 percentage points potentially.

The Fund’s baseline forecast takes account of tariffs announced by mid-September. Maurice Obstfeld, the director of the IMF’s Research Department, says he is less optimistic about a resolution to the trade dispute with the United States than he was six months ago. In one scenario modelled by the Fund, an escalation of trade restrictions could cut 1.6% of China’s GDP in 2019.

Obstfeld, who retires soon, also took what by the IMF’s diplomatic standards was a hugely political swing at ‘America First’ unilateralism. He concluded what will be his final forward to the Outook with this paragraph.

Multilateralism must evolve so that every country views it to be in its self-interest, even in a multipolar world. But that will require domestic [Obstfeld’s italics] political support for an internationally collaborative approach. Inclusive policies that ensure a broad sharing of the gains from economic growth are not only desirable in their own right; they can also help convince citizens that international cooperation works for them. I am proud that during my tenure, the IMF has increasingly championed such policies while supporting multilateral solutions to global challenges. Without more inclusive policies, multilateralism cannot survive. And without multilateralism, the world will be a poorer and more dangerous place.

Dealing with one aspect of ‘America First’, the US-China trade dispute, the People’s Bank of China has again just eased monetary policy, reversing its recent stance to rein in credit growth and address financial risks though deleverage.

The Fund says applying domestic stimulus will be at the long-term cost of delaying tackling China’s internal financial imbalances. It has advocated for some time that China should de-emphasise the quantity of growth and think more about the quality of growth and the economy’s resilience to financial instability — the shadow banking sector and over-leveraging in local government financing being two of the most glaring point of vulnerability.

“It will be important, despite growth headwinds from slower credit growth and trade barriers, to maintain the focus on deleveraging and continue regulatory and supervisory tightening, greater recognition of bad assets, and more market-based credit allocation to improve resilience and boost medium-term growth prospects,” the Fund says.

In its Financial Stability Report, issued the day after the World Economic Outlook, the IMF says:

In China, financial conditions have remained broadly stable, with an easing in monetary policy largely offsetting the impact of external pressures. China’s equity markets have weakened on rising trade tensions. Tighter liquidity resulting from earlier regulatory efforts to de-risk and deleverage the financial system has led to pockets of stress in corporate bond markets, which prompted Chinese authorities to ease monetary policy. The central bank injected liquidity via cuts to the required reserve ratio and through lending facilities. The exchange rate weakened further, down 7 percent against the U.S. dollar (and down 5 percent compared with a basket of 24 currencies) since mid-June, prompting authorities to reintroduce a 20 percent reserve requirement for foreign exchange forwards.

The trade-off between growth and stability is a difficult one for policymakers in any country. In China, that will always lean towards stability, which will likely mean a more accommodative macro policy stance and only fine-tuning to deleverage.

Hence the IMF repeats its mantra:

Despite a growing emphasis in China on the quality rather than the speed of growth, tensions persist between stated development goals and intentions to reduce leverage and allow market forces to play a larger role in the economy.

An overarching priority is to continue with reforms, even if the economy slows down, and to avoid a return to credit- and investment-driven stimulus. Key elements of the reform agenda should include:

  • strengthening financial regulation and tightening macroprudential settings to rein in the rapid increase in household debt;
  • deepening fiscal structural reforms to foster rebalancing (making the personal income tax more progressive and increasing spending on health, education, and social transfers); tackling income inequality by removing barriers to labor mobility and strengthening fiscal transfers across regions; and
  • more decisively reforming state-owned enterprises; and fostering further market liberalization, particularly in services.

Addressing the distortions that affect trade and cross-border flows is also needed.

All of which, as ever, is more about domestic political priorities than economic policymaking.

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China’s P2P Lenders Are Failing At An Accelerating Pace

REGARDLESS OF MEASURES to ease credit markets to offset any slowing of GDP growth, authorities continue to crack down on the more risky parts of the financial system.

Few pieces of it are as hazardous and ill-regulated as peer-to-peer (P2P) lending.

China has the world’s largest P2P lending industry, worth approaching $200 billion (assets, i.e. loans outstanding) flowing through (now) some 2,000 platforms with 50 million registered users.

The ranks of the P2P platforms are thinning fast, as individual operations fail — some 80 in June (a then monthly record) and around a further 120 so far this month, taking the cumulative number of failures since 2013 above 4,000 according to the Yingcan Group, a Shanghai-based research firm that tracks P2P finance.

Savers are pulling their money from many of the remainder and investors have little confidence many will survive, both factors compounding the accelerating pace of failures. Meanwhile, authorities will be worried about the pick up in the pace of failures over the past week.

Their challenge is to stop a so-far contained panic spilling over into other parts of the $10 trillion shadow banking industry and thence into the main financial system.

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China’s Second Carrier Starts Its Sea Trials

China's second aircraft carrier and first indigenously built one being towed from its fitting out berth in Dalian, northeastern China, 2018.

SEA TRIALS HAVE begun for the first domestically built aircraft carrier, state media report. Accompanying photographs (above) of the vessel being towed from its fitting-out berth in Dalian on what looks like a misty morning probably date from last month. On May 5, a Z-18 helicopter, the sort used by the Liaoning, China’s first aircraft carrier, a refit of a Soviet-era carrier, conducted a test landing and takeoff, the same precursor to the Liaoning’s sea trials in 2012. The new carrier, which is still unnamed, is expected to be go into active service in 2020, adding national pride to an increasingly potent blue-water fleet.

 

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China Readies A New Era In Financial Policymaking

Headquarters of the People's Bank of China, Beijing 2015. Photo Credit: bfishadow. Licenced under Creative Commons.

THE GOVERNANCE REORGANISATION rubber-stamped by the recently concluded National People’s Congress has significantly changed the policy-making and regulatory landscape of the financial system.

As with other parts of the administration, it has consolidated agencies and strengthened the Party’s leading role over state administration.

The People’s Bank of China (PBOC) has emerged as the institutional lynchpin of the system with the banking and insurance industry regulators merged into the new China Banking and Insurance Regulatory Commission (CBIRC) and now reporting to the PBOC.

The central bank will be headed by Yi Gang, previously deputy to Zhou Xiaochuan, now 70 and who is retiring after 15 internationally respected years as governor. Yi nominally reports to the Standing Committee of the NPC but in effect to Liu He, long President Xi Jinping’s closest economic advisor and now elevated to vice-premier in charge of economic policy.

This all leaves China’s prime minister, nominally the country’s second-ranking official and customarily the one responsible for running the economy, pretty much out of the picture. That has been the de facto case for some time as Liu has been steering financial and economic policymaking from the leading group on the economy.

As vice premier, his remit will run to the financial sector, state-owned enterprise reform, industrial policy and relations with the United States. The remit underlines the twin challenges that China faces from a level of debt approaching 300% of GDP and in dealing with a United States that seems ready to start a trade war if that is what it thinks will let it get the upper hand in what the Trump administration sees as the United States existential struggle with China.

Liu’s academic credentials and worldliness are immaculate for a policymaker. However, his bureaucratic experience does not match. Yi’s promotion at the PBOC signals not only policy continuity at the central bank as it tackles deleveraging but the need for operational expertise, which Yi, a 21-year veteran of the central bank, brings.

Similarly, the appointment of Guo Shuqing as the Party boss in the central bank, and thus Yi’s senior in its political hierarchy, adds another experienced and tough-minded financial regulator to the mix — not to mention another ally of Xi’s.

Guo also heads the new CBIRC, previously having been chairman of the China Banking Regulatory Commission where he led the crackdown on shadow financing and helped clean up the interbank lending market. He has also been prominent in taming the more ambitious overseas acquisition ambitions of some Chinese companies and has experience as a stock market and foreign exchange regulator.

How the duopoly at the head of the PBOC will work in practice is illustrated by the fact that Guo also becomes deputy governor, with the ‘reform’ mandate, while Yi has been appointed deputy Party chief.

Zhou combined both the Party boss and governor’s role (although the foreign ministry has a similar split arrangement.)

China has no truck with Western notions of central bank independence as given to the US Federal Reserve, the Bank of England or the European Central Bank. The PBOC is subordinate to the government, which in the Xi era means evermore to the Party as he strengthens the Party’s leading role.

In that light, it will be Liu who will be setting the direction of, and Yi who will be running China’s financial and monetary policy with Guo ensuring regulatory and supervisory coordination on the one hand and political coordination on the other.

All three men are long-standing advocates of financial liberalisation. However, there are urgent short-term issues to resolve, notably the United States and debt, that will slow progress toward liberalisation. Cautious opening up of access to the financial system to foreign investors and more internationalisation of the yuan will continue, albeit not at the cost in either case of deregulation elevating financial risk.

One of the reasons for the consolidation of the supervisory agencies is to cut out as much as possible the regulatory fragmentation that has allowed the shadow banking system to take root. Financial stability is the political priority right now. The marching orders from the trio’s now all-powerful boss are to clean up the debt and rebalance the economy without crashing it — or having the United States crash it for them.

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Anbang Nationalisation Underlines China’s Financial Stability Priority

Logo of Anbang Insurance Group. Photo credit: Mighty Travels. Licenced under Creative Commons.

WU XIAOHUI, THE politically well-connected chairman of the giant insurance group Anbang (his wife is Deng Xiaoping’s grand-daughter), has been in detention by authorities since last June. Now he is to stand trial for economic crimes, code for fraud and embezzlement, and the company run by personnel from the China Insurance Regulatory Commission for a year or two, an extraordinary move. The state assuming control of a private-sector business, and particularly one of this size and prominence, is unusual.

Anbang has been on an aggressive international acquisitions drive, buying such foreign trophy investments as the Waldorf Astoria in New York and a string of other luxury US hotels. Chinese firms, with official encouragement, have ‘gone global’ in recent years, rapidly expanding their international mergers and acquisitions activity.

In 2016, China overtook Japan to become the world’s second-largest overseas investor. Non-financial outward direct investment that year exceeded $170 billion, a 44% increase from the previous year, according to the Ministry of Commerce. However, such activity entails tremendous financial risk from the leverage taken on, a risk exacerbated by Chinese firms’ lack of experience with the integration and management challenges that M&A brings, especial in deals that cross national and cultural borders.

Anbang appears to fall squarely in this camp. On some estimates (its finances are notoriously opaque), it has encumbered itself with debt to the point that it is fast approaching technical bankruptcy despite having more than $300 billion of assets.

That also makes it ‘too big to fail’. State administration will provide the funding to keep its core life and non-life insurance business operationally solvent. The insurance regulator says the company’s current operations remain stable but that its solvency is seriously endangered by its ‘illegal operations’ unspecified but which presumably include its investments in prestige prime US real estate.

Last August, authorities announced a list of sectors hat should be off-limits for Chinese firms as the foreign investment spree into things like European football clubs and Hollywood entertainment businesses was exacerbating debt concerns.

More broadly, in the drive for financial stability and to forestall any systemic financial shocks, President Xi Jinping has been asserting greater control over state enterprises and reining in sprawling private conglomerates, notably the ‘big four’ — Angbang plus Dalian Wanda, Fosun International and HNA Group — that have expanded rapidly via debt-fuelled foreign acquisitions.

That quartet that accounted for 20% of Chinese foreign acquisitions in 2016. Also, there has always been a nagging suspicion that, given the quartet’s political connections, some of this M&A acted as a conduit for senior officials to get their money out of the country.

All have been ‘urged’ to sell assets and pay down their debt while state banks were told to rein in their lending to them. In January, the chairman of the Banking Regulatory Commission, Guo Shuqing, warned that ‘massive, illegal financial groups’ posed a grave threat to financial reforms and the stability of the banking system and that China would address the issue ‘ in line with the law’.

Taking Anbang into state control may be the prelude to a series of moves against the layer of private conglomerates below the ‘big four’, a group of some 25-30 companies said to be in the regulators’ sights. Despite or perhaps because of his connections, Wu’s treatment, in particular, is intended to show that no tycoon is immune from being ‘deterred’ from risky borrowing and investment overseas, or from being reminded that private M&A strategies should be integrated with national investment priorities.

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Putting Financial Stability Ahead Of Growth

IN THE SIX years since the International Monetary Fund last published a Financial System Stability Assessment of China, credit has boomed, spreading shadow banking has added complexity to the system, and moral hazard has grown as belief in the implicit state guarantee to firms and investors has remained unshakeable.

In short, financial instability risks have grown rapidly.

Within the constraint of maintaining growth and employment, authorities have responded to mitigate the risk and to put the expanding financial system on the right footing to support the ‘rebalancing’ of the economy from being led by infrastructure investment and export manufacturing to being more consumption and service driven.

There is much more to do, however, as the Fund outlines in its latest assessment.

Some of that will be politically challenging, notably allowing firms to fail, markets to fall and investors to lose money, which will be the consequences of removing the implicit guarantee that the state stands behind financial loans and products. They will also require detailed technical work on bankruptcy procedures, financial education and even social security safety nets.

Political priorities will also need to be adjusted to put financial stability ahead of economic growth. That is already starting to happen as job losses, particularly in heavy industry and primary production, and slowing economic growth more generally shows. However, the tolerance for both is greater at the higher levels of government than at the local one, where the expectation among officials that promotion depends on creating good economic growth numbers is proving hard to break. The massive task of reforming local government finances is probably a multi-decade, not just multi-year endeavour.

China Financial System Growth

Improving the supervision of the financial sector is an easier piece to bite off, and authorities have been systematically expanding that for banks, insurance companies and securities firms in recent years. The Fund recommends setting up an umbrella regulator focusing solely on financial stability to coordinate the oversight of systemic risk across sectors.

This regulator, which would be an institutional version of the recently established Financial Stability and Development Committee, will need authority and independence over the sector supervisors and an improved flow of data given the scale and complexity of the country’s financial system, especially in some of the murkier areas of shadow banking. As was seen in the West with the 2008 financial crisis, failure to monitor risks outside the regulatory perimeter can be the most damaging failure of all.

The Fund also suggests that the well-advertised rapid growth of debt requires banks to hold a plumper cushion of capital, and particularly at the larger banks that are systemically important. Greater capital reserves would not only provide a buffer in the event of a sudden or severe economic downturn, but also against the particular risk with Chinese characteristics of the extensive off-balance-sheet borrowing, notably for wealth management products, that the banks implicitly guarantee.

In the same vein, banks and financial institutions should be nudged through lending rules to stop using short-term borrowing to finance their investments and instead both lend and fund longer-term. Should it come to it, and a financial institution goes under, regulators should have their powers expanded in line with international standards to let the firm to ‘fail safely’ rather than prop it up with public funds.

Another area that the Fund urges oversight is digital finance, or fintech, which as expanded significantly in China as elsewhere. Existing oversight frameworks are often ill-fitting for the innovation that comes with fintech, though the need for systemic safety and soundness is not diminished.

The Fund calls China ‘the global centre of fintech’, noting the growth of peer-to-peer lending and the emergence of payment systems run by internet retailers such as Alibaba that are competitors to the banks’. Smartphone app WeChat’s WeBank is already a competitor to banks’ lending.

The scale of this is still small compared to the overall size of the banking system and thus not a systemic risk — yet. Nonetheless, they will need to be brought into the regulatory and supervisory scheme of things. This is starting to happen following the State Council last year launching an overhaul of internet finance oversight.

 

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