In the past decade, China has relied primarily on credit growth to fund its economic ambitions. The banks of the country are now feeling the limitations of this lending and have to raise a lot of capital over the next few years.
The way China handles this challenge will determine its economic health. With a balance sheet total of 267 trillion yuan ($ 39.4 trillion), which after the measure accommodates the world's four largest banks, the country's financial system does not operate in isolation. Whatever happens in China will have global repercussions.
China's major banks have raised or announced plans to raise 343 billion yuan, according to a recent announcement from Nomura Holdings in 201
The fundamental problem is the contradictory pressure on the industry. Despite talk of deleveraging in 2018, when nominal GDP growth slowed to 9.7 percent, total outstanding loans rose 13.5 percent. To support the economy, Chinese banks have significantly outperformed deposit growth. Deposits increased 41 percent since early 2016 as outstanding loans rose 29 percent. This has increasingly burdened the balance sheets. Officially, equity ratios in 2018 improved from 13.4 percent two years ago to 13.8 percent. In reality, this was only achieved with an accounting clock.
As the Chinese economy slowed, Beijing relied on banks to absorb both the increase in shadow assets and to continue lending to drive investment-dependent growth. With new lending 20 percent higher than new deposits in 2018 and a similar trend expected this year, capital is increasingly constrained. Almost every cut in banks' reserve requirements last year coincided with a substantial repayment to the central bank. In other words, banks are borrowing to repay the People's Bank of China.
The banks just do not have the ability to lend money, as is the case without additional capital, a plan to raise money. They have started: On Thursday, the PBOC announced measures to help banks raise funds through perpetual bonds. Whether officials also consider convertible bonds or secondary bids – to name but a few – they must accelerate permits and encourage companies to more quickly address their weaknesses in the balance sheet. Waiting for an economic slowdown or an external event to raise capital is not a smart strategy.
Because Beijing prefers state-owned enterprises over private companies, it should urge the larger dinosaurs to speed up debt relief and facilitate credit allocation for smaller businesses. China must turn its back on companies that use the largest amounts of capital inefficiently.
The amount of bank capital may not hit the headlines, but it lends faster and faster as the deposits grow, and the cushioning of the slowdown can only continue for so long. The regulators need to address this issue before it becomes a crisis.
Christopher Balding is a former associate professor of economics at HSBC Business School in Shenzhen and author of Sovereign Wealth Funds: The New Intersection of Money and Power