The party is over for Chinese banks, who have for the last
few years enjoyed record profits. Since the end of 2008, the Chinese
leadership’s desperate bid to keep the wheels of growth turning has let a flood
of credit into the banking system and led to an unprecedented US$6.2 trillion
of bank loans to state-owned companies and local governments.
Many of these loans bypassed the banks’ books entirely,
going through the so-called ‘shadow banking’ market made up of everything from
giant financial trusts to mum and dad mini-banks. After a while, even the state
banks joined the game. While the regulators turned a blind eye, the four state
banks and the smaller city banks took customer deposits, wrapped them into neat
little financial tools called ‘wealth management products’, and sold them
on to eager buyers. These included wealthy people chasing yield, real estate
developers signing property deals, and even importers short of ready credit.
This explosion into new markets was a
change for the state banks. Up until 2010 they had ‘toed the line’,
making loans to safe borrowers such as state firms, and following strict rules
on interest rates. But a tug of war was going on in the upper levels between
more conservative elements such as the People’s Bank of China (PBOC), which was
worried about risky loans, and the more aggressive politicians in the State
Council, who feared an economic slowdown.
In the end — at least until recently — the spenders won out.
Although regulators banned products that allowed banks to
move loans off balance sheets, the desire for greater yield on the part of
banks and their customers eventually prevailed. Real estate developers
previously rejected by banks suddenly discovered they could obtain loans from
trusts or, even more riskily, from what the banks like to call ‘entrusted
loans’ handed down from one lender to another.
As a result, bank profits boomed. Return on equity (profits
based on the equity the banks hold) climbed from less than 5 per cent in 2004
to 21 per cent in the first quarter of 2013.
While the banks have done well, so too have many customers.
Interest on typical three-month wealth management products stayed in line with
the deposit rate until the fall of 2010. But as credit rose, and the banking
system devised ever more complicated wealth management products, the
three-month rate soared above deposit rates.
But in June, even the more aggressive camp got nervous and
there was quiet talk about a crackdown on the shadow banking market. That
rattled the nerves of the banks and suddenly the interbank lending rate known
as the shibor tripled to 13.44 per cent. The PBOC, which traditionally
hasn’t paid much attention to the interbank market, refrained from immediately
jumping in with fresh cash — and the markets panicked. Suddenly it looked like
the policy allowing banks to ‘chase yield’ was quickly reverting to ‘toeing the
line’.
The banks are now at a crossroads. A crackdown on shadow
banking means tightening credit and a slower economy. But beyond this ‘stimulus
or no stimulus’ debate, the de facto liberalisation of interest rates has
created an uncomfortable atmosphere of competition in the banking system. State
banks accustomed to a cosy relationship with depositors and borrowers are now competing
with local city banks.
Meanwhile, new rules that would allow local governments to
issue municipal bonds will likely cause city governments to withdraw support
from the local banks. Why pay the bank a fee for a loan when the city can go to
the markets directly? And the fact that Beijing is experimenting with a
private-placement bond program for small and medium companies is another sign
of progress for the capital markets — to the exclusion of the banks.
Scrambling for deposits, stuck with growing non-performing
loans from their aggressive expansion, and declining support from their
government backers, the smaller banks are going to be forced to consolidate.
This will create cross-provincial relationships new to China’s historically
regional banking system. Other changes are likely as banks respond to the
unintended consequences of the free credit era. One thing is clear: the days of
easy money are over.
Sara Hsu is Assistant Professor of Economics at
the
State University of New York.
Andrew Collier is the Managing Director of Orient Capital
Research and was previously the President of Bank of China International.
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