Fears of a mountain of bad debt on the books of Chinese banks have persisted for years and years. But between the country’s strong growth and opaque, highly-regulated system, the size and scope of the problem has never really been apparent.
Now ratings agency Fitch, which has been sceptical about Chinese banking for a while, is sounding the alarm even louder.
With much of the world immersed in crisis, China appears to be one of the few countries where the financial system continues to function largely without a glitch, but Fitch is growing increasingly wary,” it said.
“Future losses on stimulus could turn out to be larger than expected, and it is unclear what share the central and/or local governments ultimately will be willing or able to bear.”
Note the phrase “able to bear”. Fitch’s “macro-prudential risk” indicator for China threatens to jump from category 1 (safe) to category 3 (Iceland, et al). This is a surprise to me but Michael Pettis from Beijing University says China’s public debt may be as high as 50pc-70pc of GDP when “correctly counted”.
The regime is so hellbent on meeting its growth target of 8pc that it has given banks an implicit guarantee for what Fitch calls a “massive lending spree”.
Bank exposure to corporate debt has reached $4,200bn. It is rising at a 30pc rate, even as profits contract at a 35pc rate.
Fitch traces the 2009 bubble to the central bank’s decision to cut interest on reserves to 0.72pc. Bankers responded to this “margin squeeze” by ramping up the volume of lending instead. Over half the new debt is short-term. Roll-over risk is rocketing. China’s monetary stimulus since November is arguably more extreme than the post-Lehman printing of the US Federal Reserve, though less obvious to the untrained eye.
There’s something peculiar about the way China is received in the West. Its government and economic system often seem to get a pass for committing the same moves that earn the US so much scorn. For example, China tends to win plaudits for making big, Beijing-directed bets on various industries (oil, other commodiites, electric cars) while many of those same pundits would criticise Washington for trying too hard to control the economy or “pick winners.”
The fact that Chinese banks, under pressure from a central authority, would have massive losses, is hardly surprising. Actually, surprising is an understatement. Any orthodox thinking on banking, which suggests that politicized, state-directed lending is a bad idea, would tell you that China’s banks are probably in a world of hurt. Yet generally, few seem worried that China’s banks could possibly be as badly run as their US counterparts.
For some more background on the controversy over Chinese banking system losses, it’s worth brushing up on the standoff between Ernst & Young and the Chinese government over a report, which pegged total losses at somewhere near $1 trillion, an ungodly sum given the size of their economy. Eventually, E&Y backed down after pressure from the government, though the situation raised questions about the government’s honesty (not to mention the validity of the “updated” report).
The consulting giant serves as the auditor for the state-owned Industrial and Commercial Bank of China (ICBC), one of the country’s four largest banks. According to Ernst & Young public relations staff, the report was withdrawn when their staff on the ICBC account contradicted the report’s findings, specifically arguing that the level of bad debt they had seen on the ICBC’s books did not justify a number as high as $358 billion for China’s Big Four banks, and by extension $911 billion for the entire sector. (Remember, the PBoC pegs the Big Four’s combined bad debt at only $133 billion.) Ernst & Young’s London headquarters dispatched a team to its China offices May 16 to investigate the discrepancies.
The apparent source of the difference lies in what happened in the big banks’ activities during the past four years: The Chinese banks doubled their total lending portfolio, and the PBoC seems to be asserting that all of the loans granted during that period are solid. The $225 billion difference between the Ernst & Young report and the PBoC figures comes from a different consultancy, UBS, which figured that of new $1 trillion in loans, $225 billion is the amount that are actually just more bad loans. The PBoC obviously disagrees, and apparently, at least at some level, so do some Ernst & Young staff who have been working with the ICBC, one of the PBoC’s biggest charges.
Which raises a likely outcome for this little story.
The Chinese — either via the ICBC, Ernst & Young auditors working with the ICBC or the PBoC directly — have likely pressured Ernst & Young to back off. Such pressure would not be surprising. The ICBC is by some measures China’s largest financial institution, and it plans on launching its initial public offering (IPO) in September. Another one of China’s Big Four, the Bank of China, is actually in the midst of a marketing blitz for its planned June 1 Hong Kong IPO, in which it hopes to raise $9.9 billion. The Ernst & Young report came out at a damned inconvenient time, and the ICBC is a damned important client.
Update: On a very related note, the AP passes this along:
About 20 per cent of bank lending is going into stock speculation, and another 30 per cent or so is going into the property market, state-run newspapers cited Wei Jianing, an economist with a Cabinet-level think tank, as saying.
China’s economic planners have urged banks to issue loans to support the government’s 4 trillion yuan ($586 billion) stimulus program, aimed at protecting the economy from the global slowdown by pumping money into spending on building airports and other public works.
Wei and other economists told a conference in Beijing that the huge flow of money into shares and property could be fueling risky, unsustainable price increases, China Business News and other reports said.