Borrowing costs for Chinese banks have surged the most in at least six years this month as rating companies say a cash crunch threatens to swell bad loans.
The yield spread for one-year AAA bank bonds over similar-maturity sovereign notes jumped 56 basis points so far this month to 163 basis points, the most in ChinaBond records going back to 2007. The similar AA gap widened 59 basis points to 188. Even as China Construction Bank Corp. President Zhang Jianguo said yesterday cash conditions have normalized, the benchmark seven-day repurchase rate was fixed at 6.85 percent, almost twice the 3.84 percent average for this year.
Money-market rates touched the highest level last week since at least 2003, prompting three of the largest rating agencies to warn banks may run out of cash to pay investors in their wealth management products and to extend new loans, increasing the risk their customers will default. The People’s Bank of China is seeking to wring speculative lending out of the system after total credit approached 200 percent of gross domestic product, according to Fitch Ratings.
“There could be unintended consequences from the central bank’s approach,” said Liao Qiang, a Beijing-based director at Standard & Poor’s. “We expect some deleveraging at banks’ interbank and wealth management businesses to unfold. Credit growth would slow. This could pressure banks’ asset quality.”
The one-year interest-rate swap, the fixed cost needed to receive the floating seven-day repurchase rate, touched an all-time high of 5.06 percent on June 20, according to data compiled by Bloomberg. The one-day repo rate surged to a record 12.85 percent the same day, according to a daily fixing announced by the National Interbank Funding Center.
The yield on 10-year government bonds rose 13 basis points to 3.60 percent last week, while the one-year borrowing cost jumped 51 basis points to 3.61 percent, inverting the so-called yield curve for the first time in ChinaBond data going back to 2007. The 2023 yield closed at 3.53 percent yesterday.
Bad loans at banks including Industrial & Commercial Bank of China Ltd. have increased for six straight quarters through March 31, the longest streak in at least nine years.
Chinese commercial banks’ outstanding non-performing loans rose 20 percent to 526.5 billion yuan ($86 billion) at the end of the first quarter from a year earlier, accounting for 0.96 percent of total lending, according to data from the China Banking Regulatory Commission.
Those figures don’t reflect the real amount of debt because of the ways banks move loans off their books, Charlene Chu, Fitch’s Beijing-based head of China financial institutions, said in April. Some loans are bundled and sold to savers as wealth-management products, which pay more than regulated deposits, she said. Other assets are sold to non-bank institutions, including trusts, to lower bad-debt levels.
Non-performing loans may rise faster as weaker borrowers have difficulty refinancing credit in the coming months, Moody’s Investors Service warned on June 24. The official Xinhua News Agency said in a June 23 analysis that risk is increasing in the financial system as the shadow-banking sector expands and institutions make more highly leveraged investments.
Shadow lending flourishes in China because an estimated 97 percent of the nation’s 42 million small businesses can’t get bank loans, according to Citic Securities Co., and savers are seeking higher returns. The industry may be valued at 36 trillion yuan, or 69 percent of gross domestic product, JPMorgan Chase & Co. estimated last month. The crackdown may damage the economy by shrinking funding for smaller companies, Barclays Plc said on May 20.
The nation’s outstanding amount of wealth-management products rose by 500 billion yuan to 13 trillion yuan in the first five months of this year, accounting for 16 percent of the nation’s deposits, according to estimates published by Fitch on June 10. That compares with a 4 trillion yuan increase for the whole of 2012.
An estimated 1.5 trillion yuan of wealth management products were to mature in the last 10 days of this month, Fitch Ratings said June 21. Issuance of new products and borrowing from the interbank market are among the common sources of repayment for maturing products, it said.
Fallout from unofficial lending led more than 80 businessmen to commit suicide or declare bankruptcy over six months in 2011-2012 in the southeastern exporting hub of Wenzhou, a city of 9 million residents whose 400,000 small businesses make products ranging from cigarette lighters to eyeglasses.
“The problem is that when debt levels have got so high, and it’s more debt that keeps the existing debt afloat, you absolutely have to stop the process, but it’s very difficult to do so in an orderly way,” said Michael Pettis, a finance professor at Peking University “There’s always a risk that the unwinding of the debt becomes disorderly and the PBOC will be blamed for mismanaging the process.”
About 563 new wealth products were issued last week, two-thirds more than the previous period, according to Benefit Wealth, a Chengdu-based consulting firm that tracks the data. China Minsheng Banking Corp., the nation’s first privately owned lender, is marketing a 35-day product that offers an annualized yield of 7 percent. China’s one-year benchmark deposit rate is 3 percent.
Mid-sized banks get an average of 20 percent to 30 percent of their funds from such products, according to Fitch, which didn’t name specific lenders. That makes these banks more susceptible to default risks on the products.
The China Banking Regulatory Commission told banks in March to cap investments of client money in debt that isn’t publicly traded at 35 percent of all funds raised from the sale of wealth management products. The next steps may include tightening that sends some smaller financial institutions into bankruptcy, according to analysts at Nomura Holdings Inc.
“What we will see over the next half year is credit growth overall will slow down a bit,” Stephen Green, head of Greater China research at Standard Chartered Plc, said in a Bloomberg TV interview from Shanghai. “If interbank rates remain quite volatile and at high levels, then that’s obviously going to have a bigger feed through to credit.”
The PBOC’s decision to refrain from pumping “hefty” sums into the financial system last week was a “bold but essential move to discipline unchecked lenders,” Xinhua said in a June 26 commentary, adding that the pain is needed to pave the way for a more sustainable economy.
China Construction Bank president Zhang welcomed what he called the PBOC’s “proactive attitude” to a changing market situation.
“China Construction Bank hasn’t stopped new lending in any sort of period, or to any sort of clients,” Zhang said at the opening of a bank branch in Taipei yesterday. “Recently there was a temporary liquidity squeeze condition, but CCB’s cash is so adequate that we were able to lend money to our peers. The cash shortage condition has eased in the last two days, and by now the situation has already normalized.”
The central bank, which was silent during the worst of the cash crunch, published a statement on June 24 saying there’s a reasonable amount of liquidity in the financial system and that banks should control risks from credit expansion, including those associated with maturity mismatches.
The PBOC will use all kinds of tools to appropriately adjust liquidity in the market and maintain the overall stability, Governor Zhou Xiaochuan said at a forum in Shanghai today. China will continue to implement a prudent monetary policy and allow more foreign participation in the interbank money, foreign-exchange and bond markets, he said.
“No policy maker can afford to be blamed for being responsible for an unnecessary, fully-avoidable financial meltdown and growth hard landing,” Bank of America Merrill Lynch economists wrote in a report yesterday. “With a month of mess in the interbank liquidity, it’s time to re-highlight stability and it’s time for markets to calm down.”
The cost of protecting China’s government debt from default slipped five basis points in New York to 116 yesterday and is up 29 basis points this month, according to prices from data provider CMA. The contracts pay the buyer face value in exchange for underlying securities or the cash equivalent if a borrower fails to adhere to its debt agreements. The contract on Bank of China Ltd. dropped 28 basis points to 165 yesterday and is 51 basis points higher for June.
“Smaller banks short of deposits will face significant pressure from liquidity management,” said Zhou Hao, a Shanghai-based economist at Australia & New Zealand Banking Group Ltd. “If the weakest link breaks, there’s an increase in the likelihood of creating systemic risks.”
— With assistance by Jun Luo