China’s Moderating Financing Growth Diminishes Systemic Risk Concerns, a Credit Positive

China’s Moderating Financing Growth Diminishes Systemic Risk Concerns, a Credit Positive

On 18 January, China’s central bank, the People’s Bank of China (PBoC), published preliminary data on total financing in 2011 that suggests a steep drop in 2011 non-bank funding6 growth to 25% from 45% in 2010 by our estimate, a credit positive for banks. China’s ability to slow non-bank financing growth to its current pace is helpful to the prospects of a “soft landing” in the economy and a development that diminishes our conerns about systemic risk.

Growth in non-bank financing has outpaced that in bank financing in recent years, a trend that strong capital market growth since 2007 (Exhibits 1 and 2) accelerated. Overall, this disintermediation reflects increasingly broad funding channels that allow more efficient capital allocation. The availability of these alternative funding sources is particularly important to small and medium-sized enterprises that are underserved by banks.

Chinas Total Financing Flows

However, the rapid growth (Exhibit 3) in products such as entrusted loans, bank bill acceptance, and trust loans in 2010 and the first half of 2011 followed a massive fiscal stimulus in 2009 and the authorities’ subsequent tightening of bank credit by applying bank loan quotas and a series of reserve requirement hikes. Large amounts of bank funding diverted to support multi-year government projects and tight credit condition in 2010 and 2011 forced many private sector borrowers to look for alternative credit sources. Although these products are not on banks’ balance sheets, banks play an important role in making the transactions happen. Bank bill acceptance is a trade-related product, issued by the banks and reported as an off-balance sheet item. Entrusted loans are provided by companies through the banks since in China non-financial companies are not allowed to lend. The banks are also heavily involved in making the loans via trust products.

These products’ massive growth raised questions about potential increases in systemic risks because of possible relaxation in underwriting standards and increased operational risk for banks, and prompted the authorities to tighten the financing regulations on the products. In addition, some of the transactions are not fully captured in the central bank’s statistics on bank credit, creating a danger of underestimating credit supply and undermining monetary policy. It may also add to unsustainable leverage among borrowers that eventually undermines their ability to service their bank loans.

Growth Rate of Non-Bank Financial Markets

Specifically, the contribution of discount bills, traditionally a form of bank financing, to total credit supply may be understated. Amid explosive growth in bank bill acceptance during 2010 and the first half of 2011, there was an increasing discrepancy between the amount of bank bill acceptance and discounted bills, which could be a warning sign that some of the credit provided via bill discounting may not have been accounted for. Assuming the pre-2010 relationship between bank bill acceptance and discounted bill holds, we estimate that in 2011, about RMB3 trillion of credit may not have been reported on banks’ balance sheets, or was reported under accounting categories other than “loans and advances to customer.” The amounts are therefore are not subject to the loan quota control that the authorities use to manage the total credit supply in the system.
Despite the strong growth in non-bank financing in recent years, we believe its total size remains relatively small compared to the banking system. We estimate the outstanding balance to be around 20% of total bank assets.