China Cash Crunch Puts Pressure on Small Banks, Moody’s Says

China’s worst cash squeeze in at least a decade may weigh on smaller banks’ financial strength as their reliance on interbank funding leads to an erosion of loan margins, according to Moody’s Investors Service.

Mid-sized banks got 23 percent of their funding and capital from the interbank market at the end of last year, compared with 9 percent for the largest state-owned banks, Moody’s said in an e-mailed statement today. Those banks will probably compete “more aggressively” for deposits amid the credit crunch, which would increase cost of funds, it said.

China’s money-market rates, which climbed to a record high last week before retreating for a second day today, have triggered a drop in shares of China Minsheng Banking Corp. and China Merchants Bank Co. on investor concern that funding may tighten and curtail credit growth. Slowing economic growth and efforts to rein in shadow banking have contributed to higher borrowing costs and rising bad loans.

“The ultimate goal of the policy makers is to force banks, especially the smaller ones, to deleverage,” said Wilson Li, a Shenzhen-based analyst at Guotai Junan Securities Co. “It’s time to clean up their act.”

Shares of Minsheng Bank tumbled 10 percent, or the daily limit, to 8.51 yuan in Shanghai trading. The stock fell 8 percent in Hong Kong, the most since November 2011, extending its loss this month to 24 percent. Merchants Bank, which declined 4.6 percent today in Hong Kong, has lost 20 percent this month. Industrial Bank Co. fell 10 percent in Shanghai to the lowest since December, and has dropped 26 percent in June.

Targeted Injections

The one-day repurchase rate touched an unprecedented 13.91 percent on June 20 before tumbling on signs targeted injections of funds are being used to ease a cash crunch that threatens to worsen the economic slowdown. The People’s Bank of China said in a statement yesterday that the nation should “appropriately fine-tune” its policies.

Non-performing loans may rise more rapidly in the coming months as weaker borrowers find it hard to refinance credit, Moody’s said today. Bad loans at banks including Industrial & Commercial Bank of China Ltd. and China Construction Bank Corp., the nation’s two largest, have increased for six straight quarters through March 31, the longest deterioration streak in at least nine years.

Eliminating Speculation

Premier Li Keqiang last week signaled a determination to stamp out speculation funded by cheap money by saying banks must make better use of existing credit and step up efforts to contain financial risks. The government aims to direct money toward economic growth following a credit boom that has fueled property-price gains, local-government debt risks, and a wave of wealth-management products.

Regulators are forcing trust funds and wealth management plans to shift assets into publicly traded securities, taking so-called shadow banking funds away from property developers and local-government finance vehicles. 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 outstanding amount of wealth-management products -- or financial instruments used by banks to collect funds for periods from 30 days to a year -- rose by 500 billion yuan ($81 billion) 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 Ratings on June 10.

Default Risks

Mid-sized banks get an average of 20 percent to 30 percent of their funds from such products, which pay investors higher yields than the benchmark bank savings rate, Fitch said on June 21, without naming specific lenders. That makes those banks more susceptible to default risks on the products.

Minsheng, based in Beijing, and Fuzhou-based Industrial Bank were the most aggressive in also using short-term borrowing from the interbank market to generate off-balance sheet loans that allowed them to dodge loan quotas and capital requirements, Guotai’s Li said. A significant part of such loans went to trusts, local government financing vehicles and real estate developers, he said.

“If something goes wrong on the interbank market -- such as a sudden, severe cash crunch, or some black-swan event such as a bank run -- their current business structure may not be able to withstand these shocks,” said Chen Xingyu, a Shanghai-based analyst at Phillip Securities Group. “This will force them to strengthen their internal controls and take a more prudent approach when it comes to their lending and borrowing business.”

Tapping Banks

From 2009 to 2012, mid-sized banks including China Citic Bank Corp., Huaxia Bank Co. and Ping An Bank Co. increased borrowing from the interbank market by 43 percent annually, more than twice as fast as the larger banks, according to Sanford C. Bernstein & Co. estimates from June 21. They now receive 21 percent of their interest income from interbank loans, compared with an average 5 percent for bigger lenders such as ICBC and CCB, Bernstein said.

“It is the smaller banks and the A-share listed banks that may run into either earnings headwinds or funding problems if the tightness in the interbank market persists,” wrote Mike Werner, an analyst at Bernstein.

— With assistance by Jun Luo, and Aipeng Soo

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