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Over the past decade, China has mainly relied on credit growth to finance its economic ambitions. The country's banks are now feeling the constraints of this range of loans and need to raise a lot of capital over the next two years.
How China approaches this challenge will determine its economic health. With total badets of 267 billion yuan (39.4 billion US dollars) and the fact that this measure is home to the world's four largest banks, the country's financial system does not operate in a vacuum. Everything that will happen in China will have a global impact.
According to a recent note from Nomura Holdings, major Chinese banks have raised or announced their intention to raise 343 billion yuan in 2018. This figure is well below the estimates of the UBS group, which said last year that these companies would need 1,000 to 3 trillion yuan, depending on the level of capital desired. None of these forecasts take into account the additional funds required by the Big Four to meet the Basel III requirements for systemically important institutions by 2024.
The fundamental problem is the conflictual pressure on the sector. Despite discussions on deleveraging in 2018, while nominal GDP growth slowed to 9.7%, total outstanding loans increased 13.5%. To support the economy, Chinese banks have far exceeded the growth of deposits. Since the beginning of the year 2016, while the outstanding loans increased by 41%, deposits have only increased by 29%. This has added to the balance sheets. Officially, capital ratios improved to 13.8% in 2018, compared with 13.4% two years earlier. In reality, this has only been achieved with a sleight of hand accounting.
In response to the slowdown in the Chinese economy, Beijing has relied on banks to absorb the accumulation of ghost badets and continue to provide loans to stimulate growth dependent on investment. With new borrowing exceeding new deposits by 20% in 2018 and following a similar trend expected this year, equity is becoming increasingly limited. Nearly all cuts in the banks' reserve requirements over the past year coincided with a large refund to the central bank. In other words, the banks borrow themselves to repay the People's Bank of China.
Banks are simply not able to continue to lend as much as they do without additional capital.
Chinese banks and regulators must therefore establish a fundraising plan. They began: The PBOC announced Thursday measures to help banks raise funds by issuing indefinite bonds. Whether executives are also considering convertible bonds or secondary offerings – to name just a few of the possibilities – they need to speed up approval processes and encourage companies to address weaknesses in their balance sheets more quickly. Waiting for an economic downturn or an external event to raise capital is not a wise strategy.
While Beijing is criticized for favoring public enterprises over private companies, it should encourage larger dinosaurs to deleverage more quickly, which will make it easier for small businesses to lend money. China must stop favoring companies that consume the largest amounts of capital inefficiently.
Banks' capital levels may not be front page news, but lending faster than deposits is growing, and reducing the ability to mitigate a slowdown can only take a long time. Regulators must tackle this problem before it escalates into a crisis.
Christopher Balding is a former Associate Professor of Commerce and Economics at HSBC Business School in Shenzhen and author of Sovereign Funds: the new intersection of money and power
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