Risks flagged as Chinese banks dodge loan quotas

Chinese banks are showing themselves to be Artful Dodgers of official quotas on bank lending intended to cool down the economy — and this trend of masking loans could heighten risk in China, analysts point out.

Despite official rhetoric from authorities that an avalanche of new bank loans — which have fuelled asset price bubbles and stoked inflation — is being reined in, China’s credit growth this year hasn’t slowed materially from 2009, a special report from Fitch Ratings has observed.

“Talk of a substantial slowdown in credit growth in China is premature,” noted Charlene Chu, head of Fitch’s financial institution ratings in China. “In reality, lending has not moderated, it has been diverted into other channels.”

According to Chu, Chinese banks have proved inventive in hiding new loans through a variety of devices.

One very successful method was to camouflage the amount of loans they make by holding discounted bills. Chinese banks, the report notes, have been offloading trillions of yuan in loans in 2010 by artificially reducing their holdings of discounted bills.

By the rating agency’s estimate, Chinese banks understated the balance of discounted bills by as much as 1.6 trillion yuan (or about $250 billion) at the end of the third quarter.

Alternatively, instead of buying discounted bills, banks issue fresh acceptances collateralised by the original commitments to pay up — but this, the report notes, heightens systemic risk by creating a complex web in which payment for any one transaction may be dependent on an unrelated deal involving different counterparties altogether.

Additionally, Chinese banks have been shifting loans off their balance sheets and repackaging them into structured investment products for sale to investors. Given the paucity of investment products, and the negative real interest rate on deposits, such risky propositions have drawn investors looking for higher returns.
Earlier this year, Chinese authorities attempted to crack down on this market and directed banks to bring securitised loans back on to their balance sheets by the end of 2011.

However, that order was limited to existing products, most of which would have matured by the end of 2011 anyway, notes Chu.
In Fitch’s estimation, informal securitisation continues unchecked — by its estimate, some 330 billion yuan of discounted bill purchases were camouflaged in this fashion during the third quarter of 2010.

Chu reports that overall, about 3 trillion yuan in new loans have been camouflaged by Chinese banks so far this year.

The banks’ deceitful ways make a mockery of official claims to having reined in new loans from the record of last year as part of a series of efforts to combat inflation in both consumer price and asset prices.

Late last week, the Communist Party leadership announced it would tighten its 2011 monetary stance to “prudent”.
But, according to Moody’s Analytics senior economist Matt Robinson, “Merely ensuring macro-regulation is more targeted, flexible and effective may not be enough, given emerging inflation pressures and an apparent resumption in property price appreciation.”

In his estimation, aggressive monetary tightening may be required to ensure price stability and curb property speculation.

Meanwhile, The Telgraph of London reports that the Royal Bank of Scotland has advised its clients to take out protection against the risk of a sovereign default by China as one of its top trades for 2011.

The report cites the RBS as warning that authorities will have to puncture the credit bubble before inflation reaches levels that threaten social stability.

RBS, the report adds, “recommends credit default swaps on China’s five-year debt. This is not a forecast that China will default.

It is insurance against the ‘fat tail risk’ of a hard landing, with ramifications across Asia.”