China’s banks have a deposit problem. The timing couldn’t be worse.
The virus shutdown pushed households to put their money in a safe place in the first quarter, with system-wide deposits rising by a record 6.47 trillion yuan ($912 billion). Some large banks did the same, parking their own cash at smaller peers that offer higher returns. At China Construction Bank Corp., for instance, such deposits with other institutions shot up 70.3%. At Agricultural Bank of China Ltd., they rose 61.25%.
Liquidity flowing between banks should be comforting for the broader economy, where financing pressures are squeezing companies, households and lenders. In theory, this could enable credit growth. Smaller institutions get reliable funding, and they typically end up supporting weaker, regional small-and-medium enterprises that account for 60% of gross domestic product.
But they’re also facing a profitability squeeze with a crackdown on wealth management products and lower lending rates, along with rising bad loans. Depositing the cash may help tide them through but won’t fill in the cracks in China’s financial system, relied upon by hundreds of millions of households.
The logic in this shuffle: Big banks can currently earn more from making these short-term deposits than by lending in the repo market. They can then book the returns to boost profits. Unsurprisingly, such interest-earning assets drove first-quarter earnings. The tactics worked during the Covid-19 shutdown, despite net margins shrinking and expected savings from lower rates on deposit costs, stuck at 1.5%, failing to come through. But it can’t last for long, as banks are being pushed to lend cheaply.
Small banks are the industry’s most troubled segment; jitters caused a pullback in lending in the interbank market in the first place. Why, then, does it make sense to put cash there even if the returns are higher? The risk-reward trade-off doesn’t quite tally. Lending is backed by collateral, but deposits could leave billions of dollars of cash sitting at a weaker bank for up to a year. For the deposit-taking institution, withdrawal could create more pressure. All this in an environment where liquidity is already tight, though China Construction Bank judged it “relatively ample” enough to increase its time deposits.
Troubled Baoshang Bank Co. was doing such transactions with institutions when it was seized last year. One lost more than $850 million on interbank deposits. Only a part of those were guaranteed by regulators. Another took a hit that wasn’t covered by China’s national deposit insurance.
Sure, all small lenders aren’t created equal. But policy makers have already shown concern about these higher-rate time deposits. China’s interbank network of deposits and lending is vast and tightly connected. If one pocket sees stress, the entire system feels the ripples to varying degrees. Regulators can seize and post bail for only so many institutions.
For China’s households, this should be worrying. Even if they park their money at a large, reliable bank, the lender could place that cash at a more humble peer. Savers have a claim on the institution where they deposited, but what if that bank doesn’t end up getting covered?
Considering that the gap between Chinese income and expenditure on a per capita basis has “never been this large,” according to Rhodium Group, any prospect of risk to personal assets is unsettling. This inequality is even more acute in the lower socio-economic strata.
Tough times in China’s banking system have been buffered before by trillions of yuan of savings. This isn’t the time to be playing around with that money or with the legions of ordinary people struggling to get through the crisis of their lifetimes.