China's addiction to bank lending just got worse
The capital markets have failed to make up the difference in direct finance after the tapering off of unregulated financing channels
The good news is that shadow lending is tapering off in China. The bad news is that traditional bank loans picked up right where the shadow lenders left off.
At first blush that sounds like a positive stroke for regulators: a portion of opaque funds that banks pooled off their balance sheets have been brought back on to the books. By most accounts, it is a victory for assessing China's mounting credit risks under the pressure of sputtering economic growth.
But the changing composition of the mainland finance sector is a painful reminder that the banking sector is the bearer of too much risk and that bank loans are far too dominant as a channel for finance. Nevertheless, banks' balance sheets are only set to bulge this year as Beijing halts public offerings and uses commercial lenders to funnel trillions of yuan to the stock market.
Shadow-bank finance stagnated in the first half of the year at about 35 per cent of gross domestic product with only slight growth on the year before, data from Moody's Investors Service showed. Bank lending, however, grew to 144 per cent of GDP during the period from about 133 per cent in 2014. Direct capital markets financing showed little growth - 26 per cent of GDP in the first half, from 24 per cent in 2014.
AXA data also showed that the banks filled much of the finance gap left by shadow banking.
The failure of the capital markets to make up the difference in direct finance while shadow lending slowed was a missed opportunity for reformers. The next chance could be far off.
Until mid-June, China's equities market was undergoing its biggest boom in eight years. Beijing supported the bull run, which lasted nine months and saw the market more than double in value, in the hopes of broadening the channels of finance away from bank lending.
"In the state-sponsored bull market, the original idea was to boost direct equities financing for companies," said Shen Jianguang, the chief China economist at Mizuho.
It helped, at least for the duration of the rally. Equities finance for non-financial firms was worth 425 billion yuan (HK$529 billion) in the year to June, a 128 per cent increase on the period last year, according to data compiled by the .
But since the start of a market rout after June 12, market value has tumbled by up to 35 per cent from the highs and hopes for deeper financial markets have come up short.
Late last month, the securities regulator banned initial public offerings in Shanghai and Shenzhen, freezing direct finance via China's two biggest equities markets until they are deemed liquid and stable. The last time flotations were frozen was November 2012. That held until February 2014, leaving bank loans and shadow lending to fill the deficit.
"It's definitely a setback," Shen said of the overall effects of the market turmoil on the deepening of China's financial sector.
What is more, the offloading of Chinese stocks has not only halted initial public offerings, it has also enlisted the banks to leverage up in a bailout that could cost up to four trillion yuan.
Mainland media have reported that many of China's biggest banks had lent a total of 1.5 trillion yuan to state-owned China Securities Finance Corp, which re-lent to brokers for the sole purpose of propping up share prices on the ailing market.
This was expected to continue until the market stabilises and represented a reverse in financial broadening as bank loans flood the equities market.
The banks are the prime candidates for providing the liquidity needed for such a bailout, given their girth.
Total commercial bank assets hit 144.4 trillion yuan at the end of June, the China Banking Regulatory Commission said in a report last week. The five biggest banks comprised half those assets.
The asset base of the banking sector has ballooned since the onset of the global financial crisis, when it served as a channel for a four trillion yuan stimulus package. Since 2007, it has added nearly 100 trillion yuan to its asset base, more than tripling in size. By contrast, total assets in the insurance sector hit just 11.4 trillion yuan at the end of June.
But it is the size of the sector and its lending prowess that brings with it rapidly growing risk.
In a report on the national balance sheet last month, the Chinese Academy of Social Sciences named the reduction of bank finance as one of three challenges facing the mainland economy. The academy was pointing at the financial risk that has concentrated at the banks, which could eventually lead to an overwhelming crisis for the sector's controlling shareholder, the government.
"China has long been dominated by the banking sector," said Xia Le, the chief Asia economist at BBVA in Hong Kong. "There are many efforts to change that but there are also many obstacles."
One of the biggest obstacles is an implicit guarantee from Beijing on the stability of the banks, a factor contributing to the concentration of risk as companies and people move their deposits to perceived safety.
Reformers have been chipping away at the implicit guarantee. With the hopes of reducing the guarantee over the whole sector, Beijing launched a deposit insurance scheme on June 1 that will aim to explicitly guarantee most of the more than 50 trillion yuan in household deposits.
Deposit insurance was a step forward in paring Beijing's heavy responsibility for one of the world's largest bank sectors. But many experts have called the latest bailout a step backward.
"From a support-driven perspective, it reinforces the expectations of government support for the banks," said Grace Wu, a senior director at Fitch Ratings.
The bigger they get and the safer they seem, the more Beijing has on the line.
