Tag Archives: banking

China Tilts Monetary Policy Ever So Slightly

China’s economic policymakers have shifted their stance to a certain extent. The central bank’s cut in the capital reserves it requires of banks, though tiny, trimming half a percentage point off the record 21.5% for big banks, goes beyond “fine tuning”. It shows slowing growth is now a greater policy concern than inflation, which, though remaining stubbornly high, policymakers take as having peaked. The move is cautious, and follows a similar cut for small regional banks last week, but policymakers are signaling they stand ready to loosen further if circumstances warrant.

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China’s Stimulus Two Planners Have A Weaker Hand To Play

James Kynge, of the FT’s China Confidential, writing in the parent newspaper at the weekend, makes grim reading for any European or American policymaker hoping that a second Beijing stimulus would be able to pull the world economy though its latest sluggishness:

The sustained haemorrhage of state bank deposits has swelled the unregulated shadow banking system to such a size that it now supplies more credit to the economy each month than the formal banks do, according to China Confidential, a research service at the Financial Times. This means that Beijing, which has wielded financial control as a key tool of Communist party power, now finds itself largely at the mercy of an unregulated collection of trust companies, private banks, kerb lenders and loan sharks.

Even allowing that China’s trust banks, the largest part of the shadow banking system, are registered businesses and in hock to the big state owned banks — although that is a double-edged sword; which is tail and which is dog? — and there is some local-official sway over some local underground lenders, central economic policymakers are unlikely in the new circumstances in which then find themselves to be able to replicate the instant growth they stimulated with cheap state-driven credit in 2009.

A larger concern is that even if policymakers wanted to use the large state-owned banks to deploy Stimulus Two, the banks are in no shape bank to put it into effect. Beijing has already  moved to shore up the big banks’ balance sheets. Central Huijin, the domestic arm of the country’s sovereign wealth fund, started buying shares in the country’s four largest banks on Monday to “support [their] healthy operations” and “stabilise the share prices”.

Central Huijin is already the majority shareholder in the Industrial and Commercial Bank of China, China Construction Bank, Bank of China and Agricultural Bank of China. Investors have been increasingly jittery about the balance-sheet strength of the big state-owned banks, fearing they are carrying potentially too much bad debt from the loans made since 2008 in the cause of Stimulus One.

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China Tightens Capital Requirements A Tad Further

China’s central bank appears to indulging in a little back-door monetary tightening. Reports say that the People’s Bank of China is widening its capital reserve requirement definitions of deposits to include the collateral deposited by customers against letters of credit and similar commercial banking services requiring margin deposits.

Such deposits added up to 4.6 trillion yuan at the end of July, as commercial banks used the services to skirt the lending curtailments intended by the step series of reserve ratio increases the central bank has been imposing. Caixin estimates that the new requirement will take a further 887 billion yuan ($139 billion) out of the banking system over six months, or the equivalent of a 130 basis points rise to the reserve requirement ratio, already at a record 21.5%.

Fighting inflation remains policymakers’ priority. The August consumer price inflation figure is forecast to remain above 6%, down only slightly from July’s 6.5%, a three-year high, and double the official target for the year.

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China Again Raises Banks’ Capital Ratios

Barely has the ink dried on the announcements that April’s inflation rate had come in at a higher than expected 5.3% and that China’s trade surplus has surged again, than the central bank has announced that commercial banks’ reserve ratio requirementswill be raised for the eighth time since last October by 50 basis points from May 18. This latest dab of the liquidity sponge will lift the capital reserve ratio to 21% for the largest banks. With capital inflows still running strongly, we doubt that this will be anything like the last round of tightening/sterilization despite the resumption of the central bank’s sales of 3-year bills and a hefty 50 billion yuan ($7.7 billion) auction of 3-month bills.

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More Signs Of Concern Over Bad Bank Loans

China’s banks face a new round of stress tests to see how their loan books would withstand the measures to cool the property market actually succeeding. State media report that the China Banking Regulatory Commission ordered the tests on Tuesday and instructed banks to strengthen their risk management over loans to property developers and to the off-balance sheet investment companies local governments use to circumvent restrictions on raising capital.

The banks faced a similar round of testing last year, which reportedly showed that they could stomach a 30% decline in property prices. The new round suggests growing nervousness among banking regulators about the health of the banks’ loan books and the potential for more lending to turn sour as a result of the property bubble going pop or a crisis in local government financing.

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A China Banking Crisis: Possible But Not Likely

The prediction that China faces a 60% risk of a banking crisis by mid-2013, made by Fitch Ratings senior director Richard Fox in an interview with Bloomberg, falls into that category of eye-popping but not inconceivable.  Fox’s number comes from a risk model designed by the credit-ratings agency to predict banks’ vulnerability to systemic stress in the face of sustained rapid credit growth, rising property prices and an appreciating real exchange rate.

China has ticked at least two of those boxes for a long while, and indeed, Fitch’s model put China into the most at-risk category last June, though seemingly not many noticed at the time.  The model is not infallible. It raised a red flag about Ireland and Iceland ahead of their crises but not Spain’s. Countries can also retreat from the at-most-risk zone. Brazil, France, Denmark and New Zealand are recent examples. We think China is likely to join them.

Likely though not certain. A bursting property bubble and the local government debt bomb going off (and the two are so closely linked that the one would likely trigger the other) are the banking system’s greatest vulnerabilities. Policymakers are tackling both, though neither are susceptible to a quick fix. As the raft of piecemeal measures over the past 18 months to cool property markets, soak up excess liquidity in the economy, get local government finances and governance on a tighter rein and shore up banks’ capital reserves attest, it is painstaking work.

Given the scale of China’s lending binge over the past couple of years, it is inevitable that the banks will end up with some odorous piles of bad debt on their books. The question, of course, is whether they are mountains or molehills. The rapid pumping up of capital reserve ratios and the bank-by-bank way they are being required suggests the regulators have some fix on their magnitude and which are most threatening. It is the unexpected, though, that blindsides even the best layers of plans.

Prudent macroeconomic policy is the best way of avoiding a banking meltdown anywhere. As we have noted, the shift in policy Beijing is now trying to pull off to minimize what it sees as politically threatening social disparities caused by full-pelt economic growth gives the economic planners additional priorities that will complicate prudent macroeconomic management. Further, some of the tools at Chinese policymakers’ disposal are still rudimentary, one reason that the new five-year plan makes much of the need to continue financial reform. Yet they do have one big advantage in managing a potential banking crisis: administrative guidance over both the dominant banks, which are state-owned, and their big customers, similarly state-owned. That guidance is not always followed to the letter, but if a systemic crisis loomed both banks and state-owned enterprises would soon find guidance coming with arm-twisting.

Beijing has already bailed-out the big banks once from their bad loans in the past decade, and it could do so again if necessary. It could also, we should say, would also, spread the stress of a developing banking crisis to avoid it causing a systemic failure. We still don’t think it is likely that it will have to absent that black swan, and the more progress there is on structural reform of the financial sector, the longer the odds get, but it is not impossible that it might.

Footnote: Economist Michael Pettis makes the point about the political protection of China’s banking system much more elegantly in a post on why the yuan won’t become a reserve currency any time soon (a point on which this Bystander also agrees):

It is worth pointing out that the Chinese banking system is one of the least efficient in the world when it comes to assessing risk and allocating capital, and would be bankrupt without repressed interest rates and the implicit (and sometimes explicit) socialization of credit risk.  Beijing accepts this because of the tradeoff that gives it banking stability.

Beijing greatly values this stability, even at the expense of capital misallocation, and is in no hurry to give it up by opening up the financial markets and, what’s more, for political reasons I think local governments will resist ferociously any further corporate governance reform.  Remember that the phrase “corporate governance reform” in the banking context is just another way of saying that credit decisions will be made on the basis of economic considerations, and not on the basis of government preference.  That particular reform will be politically contentious.

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The Two Instabilities

As the 11th National Committee of the Chinese People’s Political Consultative Conference, the country’s top political advisory body, meets in Beijing to ratify a new five-year plan to rebalance the economy and to tackle inflation and rising property prices, two comments from western China illustrate the Morton’s fork China’s economic policymakers find themselves somewhat uncomfortably stuck by.

The first occurred at a recent meeting of regional managers from one of the large state-owned banks. A manager from Xinjiang, we are told, complained that credit quotas imposed by the banking regulators were constantly tightening in the cause of the national fight against inflation, making his bank’s branches unable to meet the local demand for loans, demand that was rising because of the development priority now been accorded to the region by Beijing.

The central bank is repeatedly dabbing up as much of the excess liquidity in the economy as it can through interest-rate hikes, higher capital reserves requirements on banks and administrative measures such as new-loan quotas. The goal is to dampen inflation and to let down the asset bubbles inflated by the lending spree triggered by the post-global-financial-crisis stimulus.

Yet it is precisely through fixed-asset investment that the government has been able to deliver the constant economic growth that the Party sees as essential to legitimize its monopoly on power. The second comment, from Xinjiang regional chairman Nur Bakeri just this week, spells out how raising living standards through economic development is key to maintaining social stability. “Development is our top priority and stability is our greatest responsibility. Without development, there would be no stability and vice versa,” he said.

Such local political pressures lie behind not just the continued pace of new bank lending this year, but also the discovery in February by the banks’ regulator, China Banking Regulatory Commission (CBRC), that more than half of new bank lending wasn’t meeting its new credit rules designed to mitigate the fear that China’s banks are sitting on a potential dung heap of bad loans. The rules require banks to meet tougher credit and risk standards with new loans. As far as the banks are concerned it is a case of old habits die hard. For years and years and years, China’s growth has been fueled by fixed asset investment financed through government-directed bank lending. Flash the cash and the devil take the hindmost.

Beijing had to bail out the big banks once to cleanse their loan books. After a couple of years of stimulus fueled record lending, it worries it may have to do so again. The recent turn to the capital markets by the big four state-owned banks has been in part to replenish threadbare capital cushions.

The CBRC has recently read the riot act to the banks for their continued lax lending. More detailed — for which read, stricter — regulations on things like capital adequacy and leverage ratios are likely to be announced later this month or early next, once the horse trading between the regulators, the industry and the myriad of official agencies with an oar to shove in to in these particular waters, has been completed. These will bring China broadly in line with international standards, and in some cases be much tougher.

They won’t completely mitigate the regulators’ darkest fears about bad loans. The CBRC is still acutely concerned about banks’ lending to the captive investment vehicles of local governments intended to get round restrictions on direct capital raising from banks. Banks had lent at least $1.2 trillion this way to local governments as of June 30th, with 23% not backed by cash flows. The CBRC’s new rules in February were particularly tough in this regard, as they were for real-estate lending. As we noted earlier, regulators have reportedly told banks to recalculate their capital levels using higher risk weightings for their loans to local governments via captive investment vehicles. It will be a nervous-making wait for the results. As the finance ministry noted in its budget report, “local governments face debt risks that cannot be overlooked”.

How much the Party can risk slowing down the economy  to minimize the risk of a hard landing if bubbles go pop and yet still keep real living standards rising is the calculation that now has to be made in Beijing. Late last month Prime Minister Wen Jiabao set an expectation that annual growth rates will slow. He said the government would target 7% annual GDP growth for 2011-15, though it wasn’t so long ago that growth of 8% a year was said necessary to generate sufficient jobs to absorb new workers coming onto the labor market and thus ensure social stability. Diverting GDP growth into social services and income-tax cuts to offset the effects of inflation is now seen as a greater guarantor of stability than providing jobs, it appears, to a government that is seemingly increasingly if unnecessarily rattled as it enters a period of economic, political and foreign-policy transition.

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China Tweaks Regional Banks’ Capital Ratios, Frets About Local Gov’t Debt

China’s central bank is acknowledging a badly kept secret, that it is applying different capital reserve requirements to different banks. Xinhua reports that 40 regional banks with low capital adequacy ratios, rapid lending growth and a high risk loan book have been the subject of individually differentiated reserve requirements.

Capital reserve requirements are one of the main tools used by the central bank to mop up the inflation-driving excess liquidity in the economy. Last week, there was a further 0.5 percentage points rise in the benchmark ratio, the eighth increase since the beginning of last year. Large banks are now required to maintain capital ratios of 19.5%. Small and mid-sized banks will have to set aside upwards of 16% of their deposits as reserves, Xinhua says. Some banks are already said to have had a 20% ratio imposed.

Meanwhile, Bloomberg reports that regulators have told banks to recalculate their capital levels using higher risk weightings for their loans to local governments via captive investment vehicles used to get round restrictions on raising capital from banks directly. We have noted the risks inherent in these before. Banks had lent at least $1.2 trillion this way to local governments as of June 30th, with 23% not backed by cash flows. It is these latter loans that particularly concern regulators and to which the highest new risk weightings, 300%, will be applied.

No official word on any of this that we’ve seen, but Bloomberg says the deadline for recalculation is March 31st, and it could reduce the capital ratios of the country’s five biggest lenders to near the regulatory minimum. Last year, authorities cracked down on such lending after a surge fueled concern that it could lead to a wave of defaults that could rock the banking system.

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ICBC Comes To America

As President Hu Jintao was leaving the U.S. after his four-day state visit, Industrial & Commercial Bank of China announced plans to move in. ICBC, the world’s largest bank by assets, has agreed to take control of Bank of East Asia’s U.S. operations, which include 13 retail bank branches in New York and California. ICBC is to pay $140 million for an 80% stake, subject to approval from Chinese and American regulators, Hong Kong-based Bank of East Asia says. The two struck a similar deal last year with ICBC taking 70% of Bank of East Asia’s six Canadian branches.

Chinese investments in American financial services firms by taking minority stakes in the likes of Blackstone and Morgan Stanley have a hapless record, mostly because the last round came before the global financial crisis of 2008 which made a nonsense of the valuations. Buying a network of retail branches is a new tack, and echoes what Chinese banks having been doing elsewhere in the world, if not yet in the U.S.

Jiang Jianqing, ICBC’s chairman, says:

This unprecedented acquisition of a controlling stake in a U.S. commercial bank by a mainland bank is strategically significant. The successful completion of this transaction will not only establish a good foundation for the provision of holistic financial services by a mainland bank in the U.S., but also will mark a new era of open-market co-operation between China and the U.S., and have a positive impact on Sino-US trade relations.

A previous attempt to buy a bank in the U.S. was torpedoed by Washington’s Committee on Foreign Investment in the U.S. (CFIUS), which reviews proposed foreign acquisitions of U.S. firms on national security grounds. The committee will be among the regulators weighing in on ICBC’s deal because ICBC is state-owned. The bank already has a securities business in the U.S., bought from BNP Paribas last year, but the purchase of retail banks comes under closer regulatory scrutiny. That is as much an examination of the acquiring bank’s home regulatory regime as it is of the bank itself.

ICBC can expect to wait a while. It took the bank two years to get a license for its existing commercial banking branch in New York. Whether the process is swifter in this case would be a good barometer of the state of Sino-American relations in the wake of Hu’s visit.

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China Raises Banks’ Reserve Ratios Again

China’s liquidity sponge just keeps on dabbing. The central bank has raised banks’ reserve requirements ratio again, by half a percentage point, taking it to 19% for most banks. It is the first such move of the year, but follows six increases in 2010. December’s consumer price inflation numbers, due out next week and expected to show a 4.7% year-on-year rise, are likely to show that inflation peaked in November at 5.1%. But with the money supply, on its broadest measure, M2, increasing by 19.7% last year and new bank lending getting off to a brisk start to the year, there is plenty of mopping up still to do.

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