Great wall of worry looms over China's banks
A spate of bank runs underscores the complex task confronting Beijing as it seeks to deal with its legacy of debt at a time when growth is getting crunched by the trade war with the US.
Robert GuySenior Writer
Nov 14, 2019 — 4.58pm
As Mike Henry slips into BHP's top job he should be keeping a wary eye on China's banking sector.
The Big Australian has profited handsomely from Beijing's liberal - arguably reckless and imprudent - use of debt to soup-up growth in the world's most voracious consumer of commodities. But the miner's new boss confronts a very different reality from his predecessors: a slower growing China struggling to shake off a debt binge hangover.
Reports of a spate of bank runs and regulators scrambling to contain the mess underscores the stresses in the world's largest banking sector as slowing growth, weak exports and crimped cash flows pressure the ability of borrowers to service China's very large mountain of debt.
Jitters about the financial health of banking minnows in the provinces of Liaoning and Henan are just the latest data points highlighting the pressures on China banks.
Earlier this year, Beijing orchestrated the bailouts of three smaller lenders in as many months, volunteering industry giant Industrial and Commercial Bank of China into "national service" to help buttress the wobbly balance sheet of one lender gone awry.
President Xi Jinping has acknowledged the problem by focusing on de-risking China's economy and financial system by reining in leverage. The conundrum is how to deal with the risk without crushing growth and igniting financial instability.
It's a serious concern given regime legitimacy depends on a growing economy and plenty of jobs.
The days of stop-start credit-fuelled growth appear to be over if the latest credit data is any indication. New loans fell to the lowest level in nearly two years.
The question is whether Beijing can resist pulling the trigger on another big credit splash if growth goes pear-shaped? Mike Henry may hope the temptation proves too great.
China bears, who have long - but so far wrongly - forecast a financial crisis, reckon Beijing will struggle to rein in leverage - which has risen from 155 per cent of GDP in 2008 to 280 per cent in the second quarter of this year - without imperilling economic growth and financial stability.
Such a massive accumulation of debt may have been easily digestible in the days of double-digit growth. Not so much now with growth bumping along at a 30-year low of 6 per cent - if the numbers are to be believed.
Compounding the issue is the deflation stalking China's manufacturing heartland. Weak demand thanks to the trade war, combined with overcapacity (funded by, you guessed it, easily accessible debt), has forced down wholesale prices.
That deflation is toxic for business borrowers as it pushes up real - or inflation-adjusted - interest rates on their debt.
According to JPMorgan, interest payments were equivalent to about 69 per cent of new credit in the first half of 2019, which implies that a growing amount of new debt is being used to service existing debts.
It's important not to tar all of China's banks with the same brush. The big four banks report non-performing loans of around 1.5 per cent, a number that prompts guffaws from more bearish analysts.
That China's banks trade around 0.65 times book value strongly suggests investors are somewhat sceptical when it comes to reporting of NPLs.
But NPLs are much higher among smaller lenders, especially those which enthusiastically embraced shadow banking.
Beijing's tightening of regulations is tacit acknowledgement it was too slow to yank on the leash of shadow banking.
New research from the Bank for International Settlements underscores the risks to China's economy from the rapid growth of a shadow banking sector with Byzantine complexity.
What makes the research interesting is it was penned by a People's Bank of China insider, Guofeng Sun, a director general of the bank's research institute.
He concludes that shadow banking drove up banks' credit risks and they "have not adequately assessed that risk or taken appropriate countermeasures".
He adds that it "undermines the effect of monetary policy" and warns the effectiveness of some regulatory policies and tools had been "compromised or partially offset by the shadow banking system".
China is a dealing with a problem of its own making. The slow growth and deflation that has cursed Japan's economy after its credit boom in the 1980s should have served as a salutary lesson on the dangers of debt for Chinese policymakers.
Unfortunately not. The jury is still out as to whether Beijing can prove this time will be different.