China’s Banks Are Still in Trouble
A new lending scheme will buy some time. But it can’t fix larger problems.
You wouldn't know it from the government's optimistic pronouncements, but China's banks are still under significant stress. Although the latest plan to help them out won't solve any fundamental problems, it will buy time -- maybe enough to come up with better ideas.
By several measures, Chinese banks are strained. Their official loan–to-deposit ratio increased from 65.8 percent in June 2015 to 71.2 percent at the end of March. New deposits peaked in 2015 and have since failed to keep up with lending growth. Last year, new loans amounted to 100.1 percent of new deposits. Through the first five months of this year, they were running at 104 percent.
With matters getting worse, the People's Bank of China has stepped into the breach. Since 2015, the PBOC has boosted lending to banks by more than 300 percent, to $1.5 trillion. Beyond just providing liquidity, it's also pushing banks to change their lending patterns: In particular, by allowing short-term debt to expire and rolling it into loans of longer duration. Since January 2017, medium- and long-term loans have made up 85 percent of all new bank lending.
This "twist" complements a broader shift in policy. A reserve-rate cut in April was intended primarily to help banks repay existing PBOC loans. Last week, the central bank said that it would accept a wider range of lower-grade assets as collateral, including AA-rated bonds and loans to small and medium enterprises. All these measures are intended to make it easier for banks to borrow from the PBOC.
That may sound odd at a time when China is otherwise trying to reduce credit, notably by cracking down on interbank lending and wealth-management products. But as a recent report from UBS Global Research noted, due to a "sharp uptick" in issuance of institutional certificates of deposit, as well as continued PBOC assistance, wholesale funding actually increased by 1 trillion yuan last year. Far from reducing leverage, regulators are mostly pushing it into other channels.
That’s because China is pursuing conflicting goals. It wants to slow credit growth but sustain economic growth. It wants to push debt out of the shadow-banking sector and onto formal balance sheets, but the official banking sector is too capacity-constrained to accommodate it -- and thus needs more credit. By lengthening durations and pumping money into the system, the PBOC is hoping to square these circles. But it's really only delaying things.
Meanwhile, these measures are eroding banks' ability to respond to potential shocks. Earlier this year, regulators reduced the level of reserves that banks must hold to guard against bad loans, which in the short term can help boost profits. To compensate, they've also approved new tools to raise capital levels, such as convertible-bond offerings. But the amount of new capital banks will need over the next few years remains enormous.
Moreover, this surge in domestic liquidity is what drove commodity prices higher and pushed the nominal gross domestic product deflator from its trend average of 1.1 percent up to 4.1 percent in 2017. Consequently, investment as a share of the economy, which had been falling for most of the past decade, flattened last year as China fell back on smokestack industries to boost growth.
If it is ever going to break this cycle, China must use the time it buys by lengthening repayments to institute some actual credit restraint. Despite intense sloganeering in recent years -- Deleveraging! Supply-side reform! Debt-to-equity swaps! -- growth in total debt continues to outpace growth in nominal GDP. A new quantitative twist may provide some breathing room, but it won't provide political will.
Ultimately, China must confront a stark equation. It can have higher credit and faster GDP growth or reduced credit and slower growth. But it can't deleverage and boost the economy at the same time. Even the PBOC's financial engineers can't avoid the tradeoffs demanded by economic reality.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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Timothy Lavin at email@example.com