Why China is asking banks to sacrifice profits and tightening property sector controls

With limited policy room and a deeply leveraged economy, China’s central bank is pushing forward with new policy thinking, implementing targeted measures in specific sectors

Hao Zhou

Published: 1:30am, 2 Sep 2020

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On August 20, a meeting between Chinese regulators and property developers was held in Beijing. While there is little concrete information in the statement later issued by the Ministry of Housing and Urban-Rural Development and the People’s Bank of China, the meeting still attracted much attention as it was reported that the Chinese authorities has set “three red lines”.

Specifically, the measures aim to control the scale of property developers’ debt. The red lines are: a 70 per cent upper limit for a developer’s debt-to-asset ratio after excluding advance receipts; a 100 per cent upper limit for the net debt-to-equity ratio, and; a one-to-one down limit ratio for cash against short-term debts.

Media reports also said property developers would be classified according to the key debt indicators. Those at the red and yellow level would be subject to tighter access to funding.

Obviously, this is in line with Beijing’s overall trend towards tightening control over the property sector. However, compared with the past rounds of tightening, which targeted banks and local governments, the new warning system appears to be more specific – property developers with high debt and leverage are likely to be badly punished.

That said, while property tightening sounds familiar, the approach has been different this time – Beijing is focusing on targeted measures. In the past, the central government preferred blanket tightening – for instance, raising the interest rates of mortgage loans, or having banks comply with a limit for property financing.

A man works on a crane at a construction site in front of Lujiazui financial district in Shanghai on July 16. China’s property developers will be classified according to their level of debt, with those that are highly leveraged subject to tighter controls on borrowing. Photo: Reuters

Following the same logic, there is also a new approach on other policy fronts. In its latest monetary policy implementation report, the Chinese central bank says it is necessary to effectively give full play to the “precise drip irrigation” role of structural monetary policy tools, improve the “direct” nature of policies and continue to make good use of the 1 trillion yuan (US$146 billion) reloan and rediscount facility.

For US Federal Reserve and European Central Bank watchers, terminology like “precise drip irrigation” sounds a bit strange. However, if you track the open market operations by the People’s Bank of China recently, you might get a sense of what it means.

The PBOC on June 11 said the daily open market operation timings will be adjusted to 9am to 9.20am from 9.15am to 9.45am to manage market expectations in a timelier manner. Since then, the PBOC has conducted open market operations of below 50 billion yuan and even 10 billion yuan. Such a small volume was very rare in the past.

In the meantime, market interest rates have been stabilising. In particular, the daily range of the overnight repo rate has largely settled at around 1.5-2 per cent. These examples illustrate what “precise drip irrigation” means.

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Another key policy innovation is the “direct nature of policies”. On June 1, the PBOC and the China Banking and Insurance Regulatory Commission announced the launch of two new monetary policy tools: the financial inclusion micro-and-small enterprise (MSE) loan extension support tool and the financial inclusion MSE credit loan support plan.

Under the support plan, the PBOC will purchase up to 40 per cent of the financial inclusion MSE loans made by regional banks from March 1 to December 31 this year, expected to add up to around 40 billion yuan.

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However, the actual cost-cutting target is much higher than 40 billion yuan. The government has called on banks to sacrifice as much as 1.5 trillion yuan in profits this year to finance cheap loans, cut fees, defer loan repayments and grant more unsecured loans to help small businesses survive the downturn caused by the coronavirus lockdown.

By the end of July, the outstanding loan volume in China was about 172 trillion yuan. A reduction of 1.5 trillion yuan in interest payments, if we do some back of envelope calculation, implies about a 90 basis point cut to lending rates.

People walk past an ICBC branch in Beijing on April 1, 2019. Chinese banks have been asked to collectively sacrifice around 1.5 trillion yuan in profits this year. Photo: Reuters

According to the PBOC’s monetary policy implementation report, by the end of June, the weighted average lending rates were 5.06 per cent, 38 basis points and 60 per cent lower than the level in December and June 2019 respectively. Hence, this still falls significantly short of the PBOC’s annual cost-cutting target.

To achieve this ambitious target, the Chinese central bank might cut the benchmark lending rates aggressively. Nonetheless, after the recent statement that the monetary policy stance will become “normal”, there is little indication that the PBOC will engage in a new wave of rate cuts.

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The “mission impossible” will ultimately require commercial banks to sacrifice profits, which means Chinese policymakers have opened a new door to prevent the economy from slumping. Certainly, the medium-term risk is that financial stability could be endangered as banks will lack a sufficient buffer to cover the growing non-performing loans.

However, if many small firms can weather the headwinds, millions of jobs will be saved, which is much more important to Beijing at this time.

All told, these developments suggest a new policy and policy-execution approach, indicating that Beijing is making every effort to protect the economy and the jobs market. This was inevitable as China’s policymakers have limited room to manoeuvre, given the highly leveraged economy, forcing Beijing to drill deep into the details.

Hao Zhou is senior emerging markets economist at Commerzbank

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