London Telegraph Chinese banking: a Wild West in the Far East? China’s banks are now the biggest in the world but fears are growing they are very unstable, writes Harry Wilson. By _Harry Wilson_ (http://www.telegraph.co.uk/journalists/harry-wilson/) 8:00PM BST 06 Jul 2013 As Government ministers ponder whether to split Royal Bank of Scotland into a “good bank” and a “bad bank”, it is worth remembering that China did something similar with not one big lender, but four at the turn of the millennium. In October 1999, a month before Fred Goodwin began his ill-fated reign as chief executive of RBS, the Chinese government created four massive “asset management companies” that would eventually take on toxic loans valued at $480bn (£320bn). Thirteen years on, these bad banks still exist, operating out of office blocks dotted around Beijing and Hong Kong, and continue to hold non-performing loans worth Rmb1.7 trillion (£180bn), according to credit rating agency Moody’s. Largely unknown to the outside world, they are a reminder that China’s banking system remains as prone to boom and bust as any Western economy and perhaps more so. As the rescue showed, the “Big Four” banks were, and are, not just “too big to fail”, but the beating heart of the entire Chinese economic system, controlling nearly half the country’s $19 trillion of financial assets. Taken together, the four largest lenders, Industrial and Commercial Bank of China (ICBC), China Construction Bank, Agricultural Bank of China and Bank of China have a combined market capitalisation of £470bn, about £200bn more than the total value of Britain’s five largest lenders. ICBC alone has 393m individual customers, the equivalent of a single bank managing the bank accounts of every man, woman and child in western Europe, and this year became _the first Chinese lender to top The Banker magazine’ s annual table of the world’s biggest banks by market value_ (http://www.telegraph.co.uk/finance/globalbusiness/10151526/Worlds-richest-bank-is-Chinese. html) , with a total capitalisation of $236bn. Ranking the world’s banks by profits made, the top four positions are now taken by China’s behemoths. Hold on everyone, the Chinese are not coming, they have arrived. Despite paying negative savings rates — the 3.5pc base rate interest on Chinese deposit accounts is generally believed to be well below the real rate of inflation — 70pc of Chinese household wealth is held in cash and bank deposits. Just over a third of India’s private wealth is kept in its banking system. With this largely captive market, citizens’ savings have been used to fund an infrastructure and property boom on an unprecedented scale and led to warnings of an asset bubble. While official figures show a 113pc increase in property prices in the past eight years, research by Tsinghua University and the National University of Singapore found prices actually rose by 250pc between 2004 and 2009, a faster increase than was experienced by the US in the lead to the sub-prime crisis. Carson Block, of Muddy Waters Research, which has laid bare several accounting scandals in Chinese companies, thinks the problems in China’s banking system are more severe than those which kick-started the global crash in 2008. “We believe that the domestic Chinese banking system is a mess, with an enormous amount of bad loans, or loans waiting to go bad. The problems of China’s lenders are greater than those of Western banks on the eve of the financial crisis,” he says. So, as Chinese lenders take their place at the pinnacle of the world’s banking system, the warning appears to be that things could be about to go very wrong, very quickly. The risks to the banks come largely from three areas: loans to local governments, loans to property developers, and the shadow banking system. As of last September, about 14pc of all Chinese bank loans, or Rmb9.3 trillion of debt, was accounted for by local governments. In large part, this money has been used to finance a vast infrastructure spending spree. While detailed information on local government finances is not available, analysts at Nomura believe that much of this investment is unprofitable and is only being financed through land sales, which have stalled in the past two years, and the sale of new debt to repay existing loans. This process is reaching its limit and local government financing vehicles will need to find Rmb1.8 trillion (£197 billion) this year just to repay their existing debt, according to Nomura — an amount greater than the total amount of urban construction bonds sold in 2012. Banks also have a direct exposure to property developer loans of Rmb3.9 trillion (£426 bn), giving rise to fears of new non-performing loans as developers struggle to find buyers for their latest projects amid a downturn in demand.# Most worrying of all is the shadow banking sector. This amorphous network of trust companies, credit guarantee companies and “wealth management products” has ballooned in the past five years as the central government has sought to limit the major banks’ lending at the same time as it has attempted to sustain economic growth with a series of stimulus packages. Back in 2008, the assets managed by trust companies stood at just Rmb1.2 trillion (£130 bn). However, by the end of last year this had grown to Rmb7 trillion, with trusts overtaking the Chinese insurance and mutual fund sectors in terms of the total funds placed with them. Though Chinese savers might be wary of the trusts, the attraction of a higher interest rate and the perceived backing of the state has helped put the sector in a position to fill the space left by banks. Last year, 50pc of all new credit in China was provided by these shadow banks, according to Bestinvest. “The authorities have placed increasing restrictions on the mainstream lenders in order to improve capital ratios and stave off further debt delinquency. Despite this, the central government continues to target a long-term growth rate of 7.5pc, effectively driving local governments and private companies alike into the hands of the shadow banking system to provide the necessary funding,” said the fund manager in a recent letter to clients. One of the greatest problems created by the increased reliance on shadow banks is the maturity mismatch. While most infrastructure and property investments are financed over three to five years, products sold by the shadow banks generally have a maturity of less than one year and often as little as three months. This has effectively created what Bestinvest describes as a nationwide “Ponzi scheme”, whereby existing investors’ returns are paid for from the influx of money gathered from new depositors. The funding mismatch has echoes of the problems which brought down British lenders, such as Northern Rock and HBOS, where short-term wholesale funding was used to finance an aggressive expansion in lending that led to disaster as lending markets shut in the wake of the credit crunch and the collapse of Lehman Brothers. Charlene Chu, a credit analyst at Moody’s in Singapore, has been one of the most vociferous critics of this system, and last year the credit agency cut China’s rating from AA- to A-, largely on fears about the potential cost of bailing out trust company depositors if the market collapsed. Chu pointed out that in the last 10 days of June alone Rmb1.5 trillion (£164 bn) of wealth management products were due to mature, highlighting the scale of the “maturity wall” faced by the shadow banks. “It is a Wild West atmosphere in many respects and that is one of the reasons why we are so worried,” Chu said of China’s shadow banking sector at a conference in Frankfurt last month. Trusts have frequently failed in the past and the size of the industry today is several orders of magnitude larger. The risks are clear. Among the largest sellers of these products have been mid-tier Chinese lenders. The aptly-named Evergrowing Bank had nearly 350 separate wealth management products outstanding as of the end of June and the 15 largest non-rated sellers of the schemes accounted for about half the 3,500 products in existence. Another potentially worrying sign for the banks has been the increase in pay. Though still well below the amounts paid out on Wall Street or in the City, Chinese financial services sector employees are better paid than workers in any other profession or industry. Over the past nine years, banking and insurance industry wages have grown by a compound annual average of 17.7pc, according to Credit Suisse. At the Big Four banks, the rise has been even more pronounced with average salaries increasing by 70pc in the past five years to Rmb156,000 (£17,000). As the banking industry’s problems have become clearer, the banks themselves are on the cusp of becoming less transparent. After opening up about the state of their finances over the past decade, rule changes are likely to make the Chinese banks more opaque again. Carl Walter and Fraser Howie, the co-authors of Red Capitalism and both financiers with decades of experience in China, pointed out in the Wall Street Journal last week that from 2017 onwards no Chinese bank will be audited by an international accountancy firm. “The fact is that no purely local firm has the experience required to audit some of the largest and most important banks in the world,” they wrote. The bankers pointed out that the first-ever professional audit of China Construction Bank, the country’s second largest lender, took more than 1.2m man-hours. The fear is that with non-performing loans at risk of imploding, the rule changes will not just make it easier for lenders to hide their problems, but also it is effectively an officially-sanctioned accounting policy. “The accounting rules will send China’s financial reform process back to the 1980s — all in the name of creating Ministry of Finance-sponsored 'national champion’ auditors. This is not a sound financial policy,” Walter and Howie said. With little external investment in China’s banking system, its problems may seem of minimal interest to the global economy. However, any bail-out of a major Chinese lender will be bad news for the rest of the world. It is true that unlike their Western rivals, Chinese banks have lower global salience, given their size, in the global capital markets. This is in part down to the fact that on average 86pc of the shares in the big four Chinese banks are held by the state, and also a reflection of their infrequent use of the international debt markets where total sales of debt by Chinese lenders since 2007 totalled under $8bn (£5.4bn) — one tenth the amount sold by Russian banks. However, if the banks and the wider financial system were to require a rescue package it could set in train a process that would cause chaos around the world. “Because they are state-owned, the government will most likely print money and prop them up. This will of course have dire consequences for China’s economy,” says Block. “Everyone goes on about the size of China’s reserves, but this will count for very little if they have to mount a rescue of their domestic banking system as most of these assets are denominated in dollars. What people don’t seem to realise is that funds are pretty much useless for this job,” says one senior portfolio manager at a major international bank. This is not the only problem China will face. Compared with 2000 — the time of the last bank bail-out — the economic and demographic backdrop in 2013 is less forgiving. Thirteen years ago a series of aggressive reforms, combined with entry to the World Trade Organisation and the mass migration of hundreds of millions of people from the country’s interior to booming coastal regions, helped the Chinese economy recover. Today, such routes to growth are no longer open to China, while its working age population has begun to shrink for the first time in two decades. This has heralded the end of the huge pool of cheap labour. How to deal with the banking sector’s problem is likely to create a civil war among the Chinese financial establishment, with the Ministry of Finance and the China Investment Corporation, the national sovereign wealth fund, expected to push for increased support for lenders, against the more hawkish People’s Bank of China (PBoC), the country’s central bank, and the China Banking Regulatory Commission. “The PBoC will want commercial banks to recognise non-performing loans on their balance sheets in order to inject more transparency into the financial system and assuage the perception of widening risk. But commercial banks and their owners will push back against such efforts citing the risk of capital flight and weaker assets bases,” says Nicholas Consonery, a senior Asian analyst at Eurasia Group. Problems in the Chinese banking industry could put it into competition with Asian rivals. The Bank of China is already preparing plans to hoover up more offshore deposits and is expected to increase interest rates on its Taiwanese savings accounts. This mirrors the short-lived war between banks in Britain and Ireland in 2008, following the Irish government’s offer of a full guarantee on all bank deposits. Given regional tensions, any suggestion that Chinese banks were attempting to grab more foreign deposits to shore up their domestic financial system would be inflammatory. The hope remains that the Chinese authorities have spotted the dangers early and will be able to manage the slowdown of the economy without precipitating a crisis. However, given the repeated boom and busts of the past 30 years, it seems likely that today’s highpoint will be seen in hindsight as the ultimate warning signal of a coming crash. -- -- Centroids: The Center of the Radical Centrist Community <[email protected]> Google Group: http://groups.google.com/group/RadicalCentrism Radical Centrism website and blog: http://RadicalCentrism.org --- You received this message because you are subscribed to the Google Groups "Centroids: The Center of the Radical Centrist Community" group. To unsubscribe from this group and stop receiving emails from it, send an email to [email protected]. For more options, visit https://groups.google.com/groups/opt_out.
