Over the course of the year, there’s been gallons of digital ink spilled documenting China’s ongoing efforts to squeeze leverage out the country’s labyrinthine shadow banking complex.
This discussion is paramount for two reasons: 1) targeted tightening is difficult, which means squeezing shadow conduits without curtailing the credit impulse to the real economy is a tightrope act, 2) shadow conduits finance all manner of trades, which means that when those channels get squeezed, the unwind shows up in unexpected places with unpredictable knock-on effects.
The reason point #1 is critical can be illustrated as follows:
(Citi)
In short: the global credit impulse is “made in China,” to quote Citi’s Matt King.
Point #2 is critical because the unwind of trades financed via shadow conduits has the potential to create havoc in things like commodities and, more specifically, in the metals complex. Clearly, the kind of chaos we got earlier this year has spillover potential for other EMs.
For those reasons, keeping up with what’s going on in China in terms of tightening is absolutely critical – especially at a time when the Fed is tightening concurrently.
With that as the backdrop, do consider the following excerpts from a new note out from Deutsche Bank, who notes that not only is China banking asset growth now the slowest in a decade, but banks’ collective balance sheet actually shrank in April. Here’s more…
Via Deutsche Bank
According to the PBOC, total assets in the China banking system as a whole amounted to Rmb237tr as of May 2017. The balance was up 12% yoy, which is nearly the lowest growth rate in the past 10 years (Figure 2). Looking at monthly changes in the asset balance, China banking system assets even shrank a bit in April 2017 (Figure 3). We believe the higher funding cost and tighter rules to curb asset growth (such as MPA framework) are the contributing factors of the asset growth slowdown.
Looking in detail, on the liabilities side, Chinese banks have mainly reduced interbank borrowings and interbank CDs over the past two months (Figure 4). This was a result of higher funding cost. For example, the 3-month interbank CD was priced at c.5% on average in June 2017, which was 140bps higher than that last June (Figure 7). Meanwhile, the 7-day repo rate (R007), which measures liquidity for banks and NBFIs, averaged 3.2% YTD, 65bps higher than the average in 2016.
On the assets side, Chinese banks have scaled back interbank lending and credit to NBFIs (Figure 5). Interbank lending is normally short-term, so banks have chosen not to refinance given a narrower interest spread or constraints in asset growth under MPA regulation. Meanwhile banks also reduced exposure to NBFIs, which basically represent the shadow banking exposure of Chinese banks, in our view.
Reflecting higher funding cost, mounting regulatory pressure and capital pressure, Chinese banks as a whole have reduced shadow banking credit.
- On balance sheet: Banks’ receivable investments, which are the main form of on-balance-sheet shadow banking, reduced by Rmb700bn month-on-month in May 2017 to Rmb18.9tr (Figure 8).
- Off balance sheet: After years of strong growth, AUM of banks’ WMP (wealth management products) dropped for the first time by Rmb700bn during March-May 2017 to Rmb28.4tr (Figure 9).
As a result, credit growth to NBFIs slowed notably to 16% yoy, from 50% yoy from end of 2016. Meanwhile, we note that households and government are continuously leveraging up. Household credit grew 24% yoy as of May 2017 and made up 42% of new credit in 5M2017. Government credit slowed but still recorded a fast growth rate of 37% yoy.
Of course this is a valiant effort on China’s part to the extent it’s aimed at curbing leverage and speculation.
More colloquially, this is “big trouble in little China” aimed at warding off even “bigger trouble in little China.”
The worry though, is that by virtue of its size and “mind-boggling” (to quote SocGen) complexity, the system simply can’t be dismantled or otherwise derisked without causing massive collateral damage (and “collateral” damage can be taken both figuratively and literally here).
Whatever the case, Deutsche doesn’t think we’ve seen the end of this by a long shot.
“We believe financial regulators aim mainly to contain the fast-growing leverage in China’s financial sector,” the bank writes in the same note excerpted above. “In our view, this goal has not been achieved.”
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