Contagion Risks Rise as China Banks Fund Each Others’ Loans

China’s smaller banks have never been more reliant on each other for funding, prompting rating companies to warn of contagion risks in any crisis.

Wholesale funds, including those raised in the interbank market, accounted for a record 34 percent of small- and medium-sized bank financing as of June 30, compared with 29 percent on Jan. 31 last year, Moody’s Investors Service estimated in an Aug. 29 note that analyzed central bank data. Shanghai Pudong Development Bank Co.’s first-half earnings showed its short-term borrowings and repurchase agreements surged by 75 percent in the past three years, while its consumer deposits rose just 24 percent.

Policy makers have sought to sustain an economic recovery by keeping the seven-day repurchase rate at around 2.4 percent for the past year, a level that has encouraged borrowing for investment in property, corporate bonds or risky loans, often packaged as shadow banking products. China’s banking regulator told city banks last week to learn the lesson of the global financial crisis and get back to traditional businesses. CLSA Ltd. estimates total debt may reach 321 percent of gross domestic product in 2020 from 261 percent in the first half.

“Contagion risks are definitely rising,” said Liao Qiang, Beijing-based senior director for financial institution ratings at S&P Global Ratings. “The pace of the development is concerning. If this isn’t stopped in time, the central bank will lose some control and flexibility of its monetary policy.”

Shanghai Pudong Development Bank said in an e-mailed response on Sept. 24 it has been using appropriate financing and its regular deposits and interbank borrowing have been developing properly and in synchronization. Total liabilities will be kept under control in the long run and all liquidity gauges meet regulatory requirements, it said. Rising short-term borrowing doesn’t mean its risks have climbed as well, the bank said.

“City commercial banks should change as soon as possible the situation of allocating more funds into investing than lending, and developing their off-balance-sheet businesses too fast,” Shang Fulin, the chairman of the China Banking Regulatory Commission, said in a speech to a city commercial bank conference.

The People’s Bank of China resumed longer-term reverse repos to boost borrowing costs in August and deputy governor Yi Gang said in a television interview earlier this month that the nation’s short-term goal is to curb leverage. It gauged demand for such auctions today. The benchmark 10-year government bond yield climbed slightly, to 2.73 percent from a decade low of 2.64 percent on Aug. 15.

China’s financial system is cushioned by the nation’s 148.5 trillion yuan ($22.3 trillion) of savings, even though regulators removed a rule that limited loans to 75 percent of deposits in 2015. Industrywide, the ratio was 67 percent on June 30, up from 64 percent five years ago, CBRC data show. Including shadow banking, it is closer to 100 percent for some lenders, such as Shanghai Pudong, Moody’s wrote. The rating company said the big four state banks still have “strong deposit franchises and a more prudent growth strategy.”

Short-term borrowings and repos accounted for 37 percent of Industrial Bank Co.’s total liabilities as of June 30, up from 34 percent three years ago, according to its filings. The lender’s loan-to-deposit ratio rose to 73.8 percent, up from 67.8 percent at the end of 2015
but still lower than the 115 ratio for Australian lenders. It declined to comment.

The higher the reliance on wholesale funds and investment in illiquid assets, the greater the risk of a liquidity crunch, said Christine Kuo, a Hong Kong-based senior vice president at Moody’s.

“When banks face fund withdrawals by other financial institutions, this will in turn prompt them to call back their own funds,” she said.

Banks are also buying each others’ wealth-management products and accounting for the transactions as investment receivables. A record 26.3 trillion yuan of WMPs were outstanding as of June 30, doubling over two years, official data showed. Investment receivables at 25 listed banks grew 13.4 percent in the first half to 11 trillion yuan, earnings reports show.

China Minsheng Banking Corp.’s receivables surged 77 percent in the first half, while its short-term borrowings and repos more than doubled in the past two years, company filings show. It didn’t reply to an e-mail seeking comment.

“Banks’ use of wholesale funds to buy WMPs only makes the contagion risks higher,” said He Xuanlai, a Singapore-based analyst at Commerzbank AG.


News Reporter

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