Tag Archives: IMF Working Paper

China’s Banks Grow Their Global Footprint Differently

Screenshot of IMF Working Paper, Banking Across Borders: Are Chinese Banks Different?

CHINESE BANKS ARE the largest cross-border creditors for almost half of all emerging market and developing economies. They now resemble banks from the advanced economies in their global reach.

However, are Chinese banks different from banks from other countries?

In their recently published IMF Working Paper, Eugenio Cerutti from the Fund and colleagues from the Bank of International Settlements (BIS) conclude that the answer is yes.

They find that whereas bank lending generally correlates positively with trade, foreign direct investment (FDI) and portfolio investment, Chinese banks’ lending in emerging market and developing economies correlates strongly with trade, but not with FDI. Furthermore, unlike other banks, it correlates negatively with portfolio investment.

Why this matters is that understanding the drivers of the fast-expanding global footprint of Chinese banks is critical for assessing potential risks and spillovers that could arise from crises in borrower countries, or even in China itself. Let us remember that in terms of total assets, China constitutes the largest banking system in the world and that four of the 30 largest global systemically important banks are Chinese.

BIS data shows that as of mid-2018, Chinese banks had made loans in 196 of 216 countries, accounting for 7% of total cross-border bank lending. Of 142 emerging market and developing economies, Chinese banks have extended credit in 135 of them, and 63 of them are the recipient of more from Chinese banks than from any other bank nationality. At 24%, Chinese banks’ share of cross-border lending to emerging market and developing economy borrowers is more than double that of Japanese banks, their nearest competitor at 11%.

These numbers are based on aggregating the cross-border claims extended by banks from China and the cross-border claims that are issued by their affiliates located abroad. Thus a nationality-of-ultimate-owner, rather than residency approach. Typically, only three-fifths of banks’ international lending is done out of their home country and only third of that to emerging market and developing countries, so including the affiliates avoids undercounting.

Cerutti and colleagues find, unsurprisingly, that the further the borrower is from the home country, the less ready all banks are to lend to emerging market and developing countries than to advanced economies. For Chinese banks, however, they find:

Chinese banks’ expansion resembles the global reach of banks from advanced economies when lending to emerging market and developing economies and these results turn out to be more pronounced when isolating claims denominated in US dollars. In fact, Chinese banks seem to perceive distance to their borrowing emerging market and developing economy counterparties as less of a barrier than other emerging market and developing economy banks. In that respect, they act more like US and European banks, even though most of the Chinese cross-border lending originates in state-owned banks and it is relatively more recent.

They also conclude that:

Chinese banks’ positive correlation between cross-border bank lending and trade with emerging market and developing economy countries stands out. It is much stronger than the trade-lending relationship exhibited by Japanese and European banks, and is again more in line with patterns exhibited by US banks. This strong positive correlation between bilateral trade and cross-border lending even prevails when considering the China-specific policy initiatives like the Belt and Road Initiative (BRI) or bilateral currency swap arrangements between the People’s Bank of China (PBOC) and other central banks.

On the other hand, unlike all other banking systems, past portfolio investment is negatively correlated with cross-border lending to emerging market and developing economy borrowers in the case of Chinese banks. This seems linked to China’s capital outflow restrictions and the fact that Chinese portfolio investment is mostly narrowly distributed within a few advanced economy countries. As a matter of fact, when lending to advanced economy borrowers, strong complementarities with portfolio investment emerge. There is only weak evidence on the relationship between Chinese FDI and cross-border lending.

A long- and a short-term question arise from the paper. First, will the current decline in trade due to the Covid-19 pandemic and trade tensions, lead to a decline in Chinese banks’ cross border lending? Given the correlation with trade, that would be sharper for Chinese banks than for others. Furthermore, given that much of the growth of the lending volumes of Chinese bank was driven by credits to low-income commodity exporters that had relatively clean balance sheets because of international debt-write off programmes, more of the same may look far less creditworthy post-pandemic.

Second, will Beijing’s expansion of its capital markets, particularly its bond markets, shift Chinese banks’ correlation between cross-border bank lending and portfolio investment closer to international means? If it does, it could thus increase even more both their total cross-border bank lending and global footprint.

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The Costs Of China’s Over-Investment

Most economists and policymakers agree that infrastructure investment more than exports drove China’s double-digit growth over the past decade. It is not an uncommon development path for emerging economies that do not rely on natural resource exports. China’s sheer scale makes it look an unique achievement, and it is, but in quantity rather than kind. Now close to 50% of GDP, investment is 10 percentage points higher on that measure than the ratio typical of Asia’s emerging economies in the run up to the Asian financial crisis.

The scale of China’s domestic savings has, however, let the country run such high levels of investment without becoming reliant on external funding. This has let it avoid what tripped up so many other emerging economies going down this path, not just Asian nations in the 1990s but even more painfully Latin American ones in the 1980s, a banking and/or foreign exchange crisis once foreign investors start to question the returns on their capital and realize that the cost of financing such high rates of investment had been mispriced.

It has not, however, let China avoid the underlying questions of whether the return on its capital spending is sub-par, and, if it is, whether that is distorting the cost of capital to the detriment of the broader economy and Chinese as a whole. A recently published IMF working paper, with the refreshingly to-the-point title, Is China Over-Investing and Does it Matter?* addresses those questions head on. In short, its answers are yes and yes.

That China hasn’t hit an external debt crisis, say the authors, Il Houng Lee, Murtaza Syed, and Liu Xueyan, the first two from the IMF’s China office, the third from the National Development and Reform Commission,

does not mean that the cost is absent. Rather, it is distributed to other sectors of the economy through a hidden transfer of resources, estimated at an average of 4 percent of GDP per year.

The burden of that cost, the authors believe, falls on households and, to a lesser extent, small and medium sized enterprises. The financial system effectively makes them subsidize the main vehicles of investment large, state-owned enterprises (SOEs). In other words, social welfare could be improved by increasing consumption at the expense of investment.

Meanwhile, China now requires ever higher investment to generate the same amount of growth. Absent a dramatic surge in productivity rates or exports, the authors estimate that investment would have to account for 60%-70% of GDP to sustain current growth rates. That would be both expensive and dangerous in terms of the potential threat to domestic stability.

It also suggests that, as most economic policymakers if not all within the Party recognize, the current growth model has run its course. Investment growth has to be moderated and consumption promoted. The policy implications for the new leadership, which has a more traditional SOE-centric state-capitalist cast of mind than the outgoing one, are self-evident.

*Is China Over-Investing and Does It Matter? By Il Houng Lee, Senior Resident Representative, China office, IMF; Murtaza Syed, Deputy Resident Representative, China office, IMF; and Liu Xueyan, Senior Fellow, Institute of Economic Research, National Development and Reform Commission of China. IMF Working Paper No. 12/277.

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