By Anjani Trivedi
The sturdy pillars of China’s financial system are showing signs of wear and tear. After all, there is only so much the $30 trillion banking system can prop up.
Since December, China’s central bank has pumped record amounts of liquidity, around $800 billion outstanding, into its financial system using various lending tools. More recently, it has been inching up the rates at which it provides the money to banks.
To some it looks like monetary tightening, to others more like a move to unwind leveraged trades and stem capital flight. It could be both. And it also shows the delicate task of managing the banking system’s bloated assets of dubious quality with the funding side of the system—deposits and bank borrowing—without setting off panic.
China’s banks’ capital buffers are thinning and pressures go beyond the bank’s fabled stash of bad loans. So, regulators are trying to rein in rising leverage and carry-trades by raising borrowing costs . But the central bank’s liquidity tools, while a means to help fund the banks, are instead laying the pressure on.
The circular stresses show up in a little-noticed regulatory banking ratio. The ratio of highly liquid assets to short-term cash outflows has been declining rapidly at China’s medium-size banks and is now below the regulatory limit of China’s implementation of the global banking rules known as Basel III.
After starting at 60% in 2014, the required ratio steps up to 100% by next year. This ratio is meant to help ensure banks have enough assets to convert into cash and meet short-term outflows. At one of China’s largest banks, Industrial and Commercial Bank of China /zigman2/quotes/202401350/delayed IDCBY -0.30% , the ratio fell to 133% from 145% in September last year, though still above limits. Meanwhile at smaller banks such as Shanghai Pudong Development Bank /zigman2/quotes/204296742/delayed CN:600000 +0.50% , it fell to 77% from 89% in the third quarter.
Short-term deposits in the form of broad money supply or M1 , the denominator in the liquidity ratio, have risen 20% since the second half of last year. Meanwhile, banks have pledged away their low-risk assets to the central bank’s liquidity injections, so the numerator is shrinking. Essentially, the tools the central bank uses to keep the system liquid are causing this measure of stress to rise. That could spell more troubles with policy.
Key to the banks’ sustainability is their funding . Around 70% of Chinese banks’ balance sheets are currently funded through deposits, down from 75% in 2015. For one, there is an increasing reliance on capital markets and around 20% of liabilities are now from the central bank and interbank markets. But, the types of deposits are rapidly changing, too. Some have higher value but are leveraged, others are shorter-term and prone to flight. Meanwhile, the central banks injections at higher rates of late have shifted the yield curve up, making funding more expensive.
If Beijing doesn’t tread with care, a slow wobble could start looking a lot shakier.
Write to Anjani Trivedi at firstname.lastname@example.org