Andy Mukherjee is a Bloomberg Gadfly columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

As the world frets about China's excesses in lending, the downgrade of Bank of Communications Co. by Moody's Investors Service is a reminder that investors ought to pay attention to the funding side as well.

The ratings company cut its baseline credit assessment on Thursday from baa3 to ba1, a one-rung slip that reduces its estimation of Bocom's intrinsic financial strength to "speculative" from "medium-grade." That means that without extraordinary support from an affiliate or a government, China's fifth-biggest bank -- state-backed and part-owned by HSBC Holdings Plc -- is a speculative debtor.

Blame it on the funding profile. As much as 34 percent of the bank's tangible assets were financed by wholesale markets -- as opposed to capital or deposits -- at the end of June, up from 26 percent at the end of 2015, Moody's said.

With the exception of the big four (Industrial & Commercial Bank of China Ltd., Bank of China Ltd., China Construction Bank Corp. and Agricultural Bank of China Ltd.) and Postal Savings Bank of China Co., which obviously has a sprawling deposit-taking franchise, the other lenders on the nation's top 10 list are now weaker on a standalone basis than the three biggest banks of Indonesia. That country ranks five to six levels below China on the sovereign ratings scale. 

Who Has Free Money?
The big four Chinese lenders and Postal Savings Bank enjoy a higher standalone credit assessment because of the strength of their deposit franchise
Source: Bloomberg
Notes: The ratings in boxes are Moody's baseline credit assessments; "baa" refers to medium-grade standalone financial strength and low credit risk; "ba" refers to speculative standalone financial strength and substantial credit risk in the absence of extraordinary support from an affiliate or a government. Numerical modifiers 1, 2, 3 show whether a bank sits at the top, middle or low end of its assessment category, respectively.

Credit markets like lending to banks that don't need them. But Bocom does, and it's already paying the price of that dependence. As funding costs have risen, the Shanghai-based bank's net interest margin has collapsed. The Moody's downgrade, which comes less than four months after the rating company cut China's sovereign assessment by one level, won't be helpful in boosting the lender's sub-1 percent return on assets.

Withering Away
Bank of Communications' profitability has taken a knock as its funding costs have risen
Source: Bloomberg

But there's a more somber message for investors, who have showered their love on the bigger Chinese lenders this year -- justifiably so in the opinion of Gadfly's Nisha Gopalan -- after shunning them just six months ago. Amid optimism that the worst of the bad-loan scare is behind them, whatever apprehension there is about liquidity is reserved for smaller lenders.

Take Bank of Jinzhou Co. Its loans-to-deposit ratio is a conservative 61 percent. But because it has huge investments in shadow-banking products not marked as loans, deposits are actually less than half of total assets.

Forget Loans, Watch Assets
Loans are steady, but Bank of Jinzhou's investments marked as receivables are racing ahead of deposits
Source: Bloomberg

At the start of the year, I echoed the warning of Auckland-based strategist Peter Redward that a growing shortage of deposits at a systemic level was worrying. A banking system of China's size can't possibly become overly reliant on financing from markets without implications for everything from stability of the currency to overall growth and the success of President Xi Jinping's corporate deleveraging campaign.      

So for the sake of your investors and your president, go find some deposits, Bocom.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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Andy Mukherjee in Hong Kong at

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