Banks Are Perilously Exposed to China
Until very recently, large exposure to China was seen as an advantage, a toehold in the market of the future. Now it's seen as a risk, and some of the world's most advanced companies seem to be on the losing side of a huge bet. The danger may be overstated in some cases and understated in others.
Last month, Goldman Sachs created a list of S&P 500 stocks with the most exposure to China. Inexplicably, Apple, which generates more than a quarter of its revenue from Greater China, is not on the list. Nonetheless, all but three of the 20 companies listed are in the tech sector: Wynn Resorts with its Macau casinos, KFC and Pizza Hut owner YUM! Brands and baby formula maker Mead Johnson Nutrition. The rest are mostly makers of tech components that are used to manufacture devices in China that are sold around the world. For example, 61 percent of Qualcomm's sales are in China, but Chinese-assembled mobile phones containing the U.S. company's chips are sold everywhere.
Apple's exposure may be even more risky: The company sells very expensive finished products to Chinese consumers, who are now experiencing an economic downturn. The hi-tech component makers will still sell their chips when there's a global market for finished products. If value chains change and production facilities move, say, to India, they wouldn't be severely affected, so long as the global smartphone market remains healthy. And there always will be Chinese consumers to sustain fast-food chains and baby formula makers. (Wynn may have something to worry about: Macau's gambling industry has been in steep decline for the last 15 months).
International banks, however, don't appear to be heavily exposed to China, at first glance anyway. Bank of International Settlements data show that their claims on Chinese banks, companies, consumers and public sector are quite manageable, though Australian and U.K. banks have extended a lot of credit in China in proportion to their total foreign assets:
Besides, international banks have been unusually alert to conditions in China, and have steadily reduced their claims on Chinese counterparties since the third quarter of 2014.
That appraisal may be deceptive, however. The June 2015 quarterly review by the BIS indicates that, in absolute terms, China was the eighth-largest borrower worldwide, with cross-border claims on its residents totaling $1 trillion. To put that in perspective, bank claims on Greece never have exceeded about $300 billion.
The absolute numbers for big foreign banking systems' exposure to China are starker:
U.K. banks' $198 billion in Chinese assets at the end of last year looks particularly threatening, especially given that HSBC and Standard Chartered both derive a significant portion of their revenue from China. This exposure is particularly problematic because a debt overhang is one of the Chinese economy's biggest problems. As the French bank Credit Agricole wrote in a note earlier this year:
The toxic combination of high and rising debt and cooling growth is symptomatic of the declining efficiency of investment. In this situation, more and more capital and debt have to be accumulated in an effort to maintain the level of growth and buy social harmony. These frantic efforts lead to excess, resulting in overcapacity (surplus production, run-up of inventories) and oversupplied property markets, especially in second- and third-tier cities. Rebalancing – now underway – brings falling prices, which hurt borrowers whose debt is secured by the value of these assets.
The danger to banks is far more real and potentially costly than the one facing tech and food companies. Obviously, China isn't going through a Greek-style meltdown. But there are visible warning signs for banks, including the recent stock market collapse, the ineffectual measures the Chinese government undertook to arrest it and the loss of $315 billion in international reserves in the 12 months to July 2015. Financial institutions, and countries that have become dependent on exports to China, are first in line to suffer adverse consequences.
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