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Much has been written about China’s surplus savings. The pile of deposits has been the single most important factor supporting China’s financial stability through more than a decade of reforms and commercialisation. However, the cash cushion has thinned considerably during the past couple of years, according to Fitch Ratings.
This depletion has not yet reached systemic levels, but it is enough to erode asset quality. China’s banking system is increasingly distressed, which is a combined result of excessive lending and a policy orientation that overly relies on credit controls and low interest rates, prioritises the state sector ahead of private companies and savers, and favours forbearance and support over restructuring, said Charlene Chu, a banking analyst at the credit rating agency, yesterday. And the problems could be just beginning.
“We see a lot of volatility in balance sheets and wealth management related activities,” she said. “What this ultimately means is that Chinese banks have fewer resources on hand today to deal with an asset quality deterioration, and certainly less resources than in the past to carry the economy through a period of forbearance.”
Many may find this hard to believe given that bank lending has been much more stringent in China this year. The 600bp rise in deposit reserve requirements since 2009 to 21% for major banks has indeed locked up Rmb4.4 trillion in cash that would otherwise be free (though Chu pointed out that more than 60% of the liquidity drain has been offset by other factors such as a contraction in central bank sterilisation bills).
To make matters worse, deposits are more mobile than ever thanks to a surge in wealth management offerings — and this has had an effect on banks’ liquidity. Banking reforms have allowed lenders to compete for deposits using wealth management offerings at yields of their own choosing, which has sparked an unprecedented race for new customers with little regard for the quality of the resulting assets.
Worse still, the fact that deposit rates have lagged behind inflation for 20 months has encouraged savers to shift money out of banks and into underground lending, where they are sometimes lost entirely, according to Fitch.
The Chinese government had taken a fairly hands-off approach towards the growth of the shadow banking system until markets rose red flags in places such as Wenzhou, where borrowers committed suicide or just disappeared without a trace when they could no longer afford to repay the extremely high interest rates.
Policymakers’ response to the problem has not been very proactive – simply telling banks to lend more or to reschedule payments to help borrowers stay afloat – with the result that banks have continued to issue loans even when previous ones have gone sour.
In the near term, Fitch expects the Chinese authorities to continue a selective policy of liquidity support for borrowers, including loan rollovers and restructuring, new loans and bond issuance. For now, the Rmb21 trillion in commercial bank credit capacity plus Rmb16 trillion in deposit reserve is sufficient to prevent any major short-term dislocation.
As a result of this, asset quality issues may not fully appear in non-performing loan (NPL) ratios until well into a deterioration. But if current rates of erosion continue, it is conceivable that cash constraints could become more binding in 2012.
Before the 2008 to 2009 financial crisis, the scale of new deposits entering the system each year was so immense that whether a loan was repaid or not often had little impact on banks’ ability to meet their own obligations. Whether NPLs were 1% or 20%, deposits and other inflow were usually more than enough to cover all liabilities, but those days are gone and the winter for Chinese banks may be coming.
