In the aftermath of the record cash crunch in the Chinese interbank market, many financial institutions in China and abroad have been hoping that the PBOC would either end its stance of aloof detachment or at least break its vow of silence and if not act then at a minimum promise good times ahead. Alas, despite repeated confusion in various press reports that it has done that, it hasn't aside from the occasional "behind the scenes" bank bailout. And at today's Lujiazui Financial Forum, PBOC governor Zhou Xiaochuan kept the status quo saying the central bank will adjust liquidity "at the proper time to ensure market stability." That time, however, is not now.
The reason is that the PBOC is actually doing what all other developed world banks have been mouthing off they would do but are terrified to - let the commercial banks forcibly deleverage without any central bank assistance, in order to end the capital misallocation. Or so the bank states. The bigger issue is that the lack of easing by the PBOC implicitly means massive deleveraging within the financial sector, likely compounded by asset impairments and deposit haircuts. But at least the intention is admirable.
Among the other soundbites from Zhou's speech:
- Financial markets are sensitive to signals
- China will use various tools to adjust liquidity
- China will maintain stable market conditions
- China’s economic growth is "stable" in general
- China’s growth slowdown remains in a “reasonable” zone
- China to speed up economic restructure and adjustment
- China’s economy remains a key engine for global growth
- Zhou says he is fully confident about the nation’s economic prospect and financial system
Caixin has more details of his speech:
"On one hand, the central bank will guide financial institutions for reasonable credit issuance and asset arrangement to support structural adjustment and upgrading of the real economy," Zhou said. "On the other hand, it will adopt various instruments and measures to adjust market liquidity to ensure overall stability."
The People's Bank of China said in a June 17 notice that it would leave banks to overcome any difficulties themselves. But on June 23 the stock market slumped and the next day the central bank said it offered "support" to certain banks.
Zhou also said the country's financial system was stable in general, and the bank will continue with prudent monetary policies and implement fine-tuning at the proper time.
"The Chinese economy is still a main driver of global economic growth," the central banker said. "We remain confident in China's economic development and the financial market."
At the same conference, Ling Tao, deputy director of the central bank's Shanghai branch, said that the liquidity shortage would be temporary and risks to the banking system are under control.
Ling also said the authorities have reached an agreement on a long-discussed deposit insurance system, which aims to protect depositors.
"We have long had measures to protect deposits, but they have remained inefficient and opaque," he said. "So we need to establish a clear deposit insurance system and push forward with the legislation."
Ironically, China is concerned about depositor protection just as Europe unveiled a pan-European mechanism in which depositors will be among those "haircut" to rescue failing banks. Then again, since China has over $14 trillion in deposits, or about 40% more than the US as China never developed a shadow funding system quite as advanced as that in the US, one can see why spreading the myth of impairment-remote deposits is so critical.
And putting it all together, and why China has opened a Pandora's box it has no control over any more, is Bloomberg explaining why recent liquidity events may have once again brought attention to the one thing that mere soothing words have no control over: bank solvency, and the massively underreported bad loans behind China's pristeen financial facade.
Borrowing costs for Chinese banks have surged the most in at least six years this month as rating companies say a cash crunch threatens to swell bad loans.
The yield spread for one-year AAA bank bonds over similar-maturity sovereign notes jumped 56 basis points so far this month to 163 basis points, the most in ChinaBond records going back to 2007. The similar AA gap widened 59 basis points to 188. Even as China Construction Bank Corp. (939) President Zhang Jianguo said yesterday cash conditions have normalized, the benchmark seven-day repurchase rate was fixed at 6.85 percent, almost twice the 3.84 percent average for this year.
“There could be unintended consequences from the central bank’s approach,” said Liao Qiang, a Beijing-based director at Standard & Poor’s. “We expect some deleveraging at banks’ interbank and wealth management businesses to unfold. Credit growth would slow. This could pressure banks’ asset quality.”
Bad loans at banks including Industrial & Commercial Bank of China Ltd. have increased for six straight quarters through March 31, the longest streak in at least nine years.
Chinese commercial banks’ outstanding non-performing loans rose 20 percent to 526.5 billion yuan ($86 billion) at the end of the first quarter from a year earlier, accounting for 0.96 percent of total lending, according to data from the China Banking Regulatory Commission.
Those figures don’t reflect the real amount of debt because of the ways banks move loans off their books, Charlene Chu, Fitch’s Beijing-based head of China financial institutions, said in April. Some loans are bundled and sold to savers as wealth-management products, which pay more than regulated deposits, she said. Other assets are sold to non-bank institutions, including trusts, to lower bad-debt levels.
Non-performing loans may rise faster as weaker borrowers have difficulty refinancing credit in the coming months, Moody’s Investors Service warned on June 24. The official Xinhua News Agency said in a June 23 analysis that risk is increasing in the financial system as the shadow-banking sector expands and institutions make more highly leveraged investments.
Shadow lending flourishes in China because an estimated 97 percent of the nation’s 42 million small businesses can’t get bank loans, according to Citic Securities Co., and savers are seeking higher returns. The industry may be valued at 36 trillion yuan, or 69 percent of gross domestic product, JPMorgan Chase & Co. estimated last month. The crackdown may damage the economy by shrinking funding for smaller companies, Barclays Plc said on May 20.
It is precisely this shadow banking industry that the PBOC is now targeting: an industry that if eliminated will take some 70% of China's GDP with it, unless of course, the PBOC finds a way to inject a matched amount of credit to undo what the punditry will realize with its 6-8 week usual delay, the most unprecedented forced deleveraging in Chinese history. The embedded risk? Spiralling, disorderly defaults.
“The problem is that when debt levels have got so high, and it’s more debt that keeps the existing debt afloat, you absolutely have to stop the process, but it’s very difficult to do so in an orderly way,” said Michael Pettis, a finance professor at Peking University “There’s always a risk that the unwinding of the debt becomes disorderly and the PBOC will be blamed for mismanaging the process.”
About 563 new wealth products were issued last week, two-thirds more than the previous period, according to Benefit Wealth, a Chengdu-based consulting firm that tracks the data. China Minsheng Banking Corp., the nation’s first privately owned lender, is marketing a 35-day product that offers an annualized yield of 7 percent. China’s one-year benchmark deposit rate is 3 percent.
Mid-sized banks get an average of 20 percent to 30 percent of their funds from such products, according to Fitch, which didn’t name specific lenders. That makes these banks more susceptible to default risks on the products.
Perhaps that - when bank after bank is closing operations due to the halt in Ponzi liquidity - is the time Zhou considers "proper" for further liquidity injections. Of course, as Lehman learned the hard way, the "proper" time always tends to be too late.