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Moody's Issues Stern Warning On China's Pyramid Bank Recapitalization Scheme; Has CIC Entered A Funding Crisis?

Tyler Durden's picture





 

Moody's is out with a surprisingly frank appraisal of the Chinese banking system's precarious capitalization trend, by looking at the recent RMB 54 billion capital raise in the interbank market by the domestic arm of the Chinese Sovereign Wealth fund (CIC), which was "the first part of an RMB 187.5 billion overall fund-raising
program mainly to provide additional capital to the three largest
state-owned banks, a policy lender, and a policy insurance company." As Moody's oh so correctly concludes: "Recapitalizing banks with bond proceeds from banks is credit negative
because it increases the effective leverage of the banking system.
The
transaction’s impact on the system is limited in this case because the
increased leverage is not significant, but it would be problematic if
effective leverage continues to increase and China’s economic growth
stalls." Moody's stops one step short of calling this transaction what it is: using debt purchased by other banks to recapitalize deteriorating loans on the banks' asset side: "the increases in assets and equity are artificial and without real
economic substance: the increase in reported equity on banks’ balance
sheets enables the banks to lend more and effectively leverages up the
system
.
Assuming banks fully deploy the capital raised, the resulting
increase in the risk-weighted assets would be RMB 187.5 billion divided
by 11.5% (the minimum capital requirement)." What is also not said, but is glaringly obvious, is that the Chinese sovereign wealth fund is likely in a major need of recapitalization, courtesy of its extensive US financial sector equity holdings.

From Moody's:

Last week, Huijin, the domestic arm of China Investment Corp (China’s sovereign wealth fund), raised RMB 54 billion in the domestic interbank market. It was the first part of an RMB 187.5 billion overall fund-raising program mainly to provide additional capital to the three largest state-owned banks, a policy lender, and a policy insurance company.

 

Recapitalizing banks with bond proceeds from banks is credit negative because it increases the effective leverage of the banking system. The transaction’s impact on the system is limited in this case because the increased leverage is not significant, but it would be problematic if effective leverage continues to increase and China’s economic growth stalls. Even without an official breakdown of the bonds’ investors, we think most are banks, since in China non-bank institutional investors (e.g., insurance companies and funds) are still small.

 

For the sake of simplicity, we assume banks are the only bond buyers to illustrate the effects. For the banking system, in accounting terms, the net effect of this transaction is that assets increase by the amount of bond investment and equity increases by the same amount. However, the increases in assets and equity are artificial and without real economic substance: the increase in reported equity on banks’ balance sheets enables the banks to lend more and effectively leverages up the system. Assuming banks fully deploy the capital raised, the resulting increase in the risk-weighted assets would be RMB 187.5 billion divided by 11.5% (the minimum capital requirement). The Huijin bond on bank balance sheets is a sovereign credit and requires no bank capital.

The need for large amounts of capital less than five years after the major banks’ IPOs reflects the banking system’s fast credit expansion and China’s uninterrupted robust economic growth over the past several years. The guaranteed administered spread between the loan rate and deposit rate also encourages banks to grow by expanding their balance sheets. For them, growing the loan book is much easier and quicker than developing capital-efficient businesses or exploring underserved markets that generate higher yields but are riskier and require expertise. The underserved markets include the private sector, which is more efficient and one of the drivers of sustained economic growth.

The banks’ balance sheets are expanding so fast that they very quickly run into capital constraints. Huijin’s scheme propels growth through increased leverage. Its success relies entirely on real productive growth.

After they raise capital this year, major Chinese banks have been announcing they won’t need to come to the equity market again for another three years. These announcements suggest the new capital likely won’t last long and the banks’ business model won’t change fundamentally in the near term. But pain lies ahead if China’s economic grows slows and the banking business model cannot adjust accordingly in time.

 


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Mon, 08/30/2010 - 11:05 | Link to Comment Sudden Debt
Sudden Debt's picture

who cares... you can't buy put options on that one.

Mon, 08/30/2010 - 11:05 | Link to Comment Caviar Emptor
Caviar Emptor's picture

Mr Kettle, meet Mr Pot. 

Mon, 08/30/2010 - 11:28 | Link to Comment aurum
aurum's picture

exactly...how the hell do they think US banks "arent" insolvent?

Mon, 08/30/2010 - 11:09 | Link to Comment Azannoth
Azannoth's picture

"However, the increases in assets and equity are artificial and without real economic substance: ..." Nooooo Shit!

Mon, 08/30/2010 - 11:10 | Link to Comment Rick64
Rick64's picture

Recapitalization thru overleveraging. Wonder where they got that idea?

Mon, 08/30/2010 - 11:20 | Link to Comment mikla
mikla's picture

Yeah, it's a good thing the Fed doesn't increase system leverage with silly stuff like paying banks on their capital reserves, purchasing over-the-counter securities, engaging in CDS hedge fund activities with the banks they theoretically "regulate", etc.  When we feed back Fannie&Freddie "profits" into new mortgage purchases and further leverage, it's because those profits are real.

Mon, 08/30/2010 - 11:13 | Link to Comment tony bonn
tony bonn's picture

bwwwhahahahahahahaha....moody's is issuing stern warnings to flaky chinese banks when the ones in its own back yard are poster children for fraud, insolvency, and corruption....where is edward munch when you need him?

and all of this is coming from an institution which performed bold acts of deception in affirming the soundness of cds, cdos and other crapulent financial engineering marvels?

fuck moody's

Mon, 08/30/2010 - 11:17 | Link to Comment Caviar Emptor
Caviar Emptor's picture

It's a macabre dance of thieves!

It's a banking Three Penny Opera! Ben sure won't get to play Mack The Knife :)

Mon, 08/30/2010 - 22:03 | Link to Comment Heavy
Heavy's picture
How about Macbeth?
Mon, 08/30/2010 - 11:14 | Link to Comment Caviar Emptor
Caviar Emptor's picture

Beginnings of a globally un_coordinated downward spiral? 

If CIC needs recap due to losses on US exposure, and US relies on continued mass credit from China, we have ourselves a perfect storm. Yipes. 

As a temporary solution to short circuit the spiral and provide some cover, Ben might propose that US just start printing Renminbi for external trade :-) Throw in a skyscraper or two in NYC.

Mon, 08/30/2010 - 11:15 | Link to Comment Spitzer
Spitzer's picture

Did that new Chinese rating agency not just downgrade US debt et al ?

I guess the TBTF didn't take that lightly and struck back with this.

Mon, 08/30/2010 - 11:34 | Link to Comment NotApplicable
NotApplicable's picture

Political economics is war by another means.

Of course, war is political economics by another means.

Really though, it's a win-win for both parties as they blame each other for currency manipulation, all while robbing the world blind.

Mon, 08/30/2010 - 11:26 | Link to Comment Vampyroteuthis ...
Vampyroteuthis infernalis's picture

One of the causes of the "green shoots" effect has been the continued blowing of bubbles in other parts of the world outside of US and Europe. Canada, China, Australia and etc. Those bubbles can't last forever. It will pop. The global ponzi can not run forever!

Mon, 08/30/2010 - 11:26 | Link to Comment bada boom
bada boom's picture

What about this kind of "Sternn" warning,

http://www.youtube.com/watch?v=kddI6-LwXZM

Mon, 08/30/2010 - 11:32 | Link to Comment Dollar Bill Hiccup
Dollar Bill Hiccup's picture

Don't worry, the Chinese are really smart. 

Great piece from the FT last year, "China's murky world of local finance" in the Dragonbeat section.

Local off balance sheet funding in concert with bank lending all mandated by the Central powers in Beijing and implicitly backed by Beijing. 

That sounds really smart.

How do you say "shell game" in Mandarin?

 http://www.ft.com/cms/s/0/4e1e3d4c-7654-11de-9e59-00144feabdc0.html

 

Mon, 08/30/2010 - 11:34 | Link to Comment Catullus
Catullus's picture

But this in no way applies to the federal reserve "reinvesting" mbs proceeds into treasuries.

Mon, 08/30/2010 - 11:38 | Link to Comment NotApplicable
NotApplicable's picture

Why that displays the "strength" of the underlying mbs paper, and thus the American Homeowner!

Mon, 08/30/2010 - 11:49 | Link to Comment Cistercian
Cistercian's picture

That's absolutely right!What could possibly go wrong?

Mon, 08/30/2010 - 11:35 | Link to Comment MarketTruth
MarketTruth's picture

Ok, this is getting so assinine and pot/kettle that the humor is almost unbearable as every country has their FIAT currency run to the bottom. Central banksters are using everything they can to keep the fraud going. Fraudulent accounting tricks, 'hidden' free money that is then sent to buy debt/etc with instant ~2% 'profit', etc. This will all end very, very badly.

Got gold/silver?

 

Mon, 08/30/2010 - 11:57 | Link to Comment overmedicatedun...
overmedicatedundersexed's picture

Had dinner this weekend with a Chinese PHD (math) who moved here to teach..

She ,yes ,she, said that the common folks are getting scared of the rem-bi loosing value and many are now buying.. wait for it.. PM's

anecdotal of course but her input seems more on the ground, then what we get out of the media. 

Hmm, Chinese people are not liking the paper money game either.

Seems we humans have been hard wired to

want PM's when economic conditions become

confused. 

Mon, 08/30/2010 - 12:07 | Link to Comment MarketTruth
MarketTruth's picture

Am not surprised at either the SHE part or the buying of gold/silver. Last time i as in China about 6 months ago it was extremely obvious and easy to buy gold/silver bars directly from banks and/or within various malls at the jewelry store. Unlike, say, in the EU, UK or USA where you truly have to look to buy. In China gold and silver bars are virtually everywhere for the purchasing and prominently displayed right in the main/front window.

Mon, 08/30/2010 - 11:40 | Link to Comment carbonmutant
carbonmutant's picture

Moody's is allowed to stay in business as long as they don't release the same analysis on US banks. They like the SEC are now a tool of the administration...

Mon, 08/30/2010 - 11:40 | Link to Comment trav7777
trav7777's picture

but...but...I was assured that the chinamen were going to take over the world just like the japs were in the 1980s.  I mean, I saw a few movies with this theme, for cryin out loud.

Don't worry, that magical asian centrally planned economy is IMMUNE to any laws of economics or even physics for that matter.

Mon, 08/30/2010 - 11:48 | Link to Comment Mako
Mako's picture

Yep, the crazies have no idea that all these systems are based on the same flawed assumptions.  They are all part of the global system and when it's over for the global size they will all go down the drain. 

Yep, the Japs are going to own everything then the Europeans, then the Chinamen, then I guess the North Koreans... running out false hope it looks like.

Mon, 08/30/2010 - 11:54 | Link to Comment carbonmutant
carbonmutant's picture

Chinese movies always involve a little wire work... LOL.

Mon, 08/30/2010 - 11:44 | Link to Comment Mako
Mako's picture

The system is insolvent on day number 1.   The books never balance, really what everyone is running from is a balancing of the unbalancable books.

 

Mon, 08/30/2010 - 11:49 | Link to Comment bugs_
bugs_'s picture

Deep Shah.

PS: OK for indian mafia to downgrade chinese mafia.

Mon, 08/30/2010 - 11:50 | Link to Comment oddjob
oddjob's picture

from Moody's?....thanks for the laugh shills.

 

Mon, 08/30/2010 - 11:56 | Link to Comment carbonmutant
carbonmutant's picture

American consumer solve all problems... Modern Chinese Mantra

Mon, 08/30/2010 - 12:00 | Link to Comment william the bastard
william the bastard's picture

is that the Chinese sovereign wealth fund is likely in a major need of recapitalization, courtesy of its extensive US financial sector equity holdings.

AKA source of funds

Mon, 08/30/2010 - 12:11 | Link to Comment trx
trx's picture

Well, it certainly looks like the CIC is looking to hedge themselfs:

 

China’s SWF To Invest In Nassim Taleb’s Bear Fund
Mon, 08/30/2010 - 12:32 | Link to Comment strannick
strannick's picture

 

Thank goodness 'Moody's isnt out with a surprisingly frank appraisal of the American banking system's precarious capitalization trend' Then we would be in trouble

Mon, 08/30/2010 - 13:08 | Link to Comment iPood
iPood's picture
Yuán tingju = circle jerk  
Mon, 08/30/2010 - 16:06 | Link to Comment tom
tom's picture

The fun things you can do when there's no checks and balances.

Works like this: state-owned banks use $28 billion of their fractionally-reserved money to buy long-term bonds issued by their state holding company (Huijin). Huijin then injects that $28 billion into a share issue by the same group of banks, and the central bank agrees to classify it as a $28 billion injection of "equity", even though banks actually just lent it to themselves via their holding company. Now banks are allowed to increase lending by another $240 billion.

Mon, 08/30/2010 - 16:44 | Link to Comment MichaelG
MichaelG's picture

Is 'Huijin' Mandarin for 'Enron'?

Wed, 09/29/2010 - 07:29 | Link to Comment Herry12
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