China turns to unorthodox finance

This year so far, with the exception of short-term loans, Chinese banks’ lending has not been strong. In fact, as we and many others have already pointed out, lending to non-financial corporations have been dominated by loans of short-term nature for the best part of the year, which pointed to possible weak appetite to commit funding to long-term projects.

Such characterisation of the lack of appetite to invest is particularly true for the manufacturing sector. Manufacturing is the single largest sector in terms of its contribution towards fixed asset investment, in which the growth of fixed asset investment has not picked up with the acceleration of investment in infrastructure-related investments.

The story which optimists are currently telling is that while banks lending is not strong (with the exception of the pick-up in short-term loans earlier this year, and you might argue that medium- to long-term loans are picking up a bit in the recent months), companies and local governments are still getting funding from other sources, such as trust loans and corporate bonds. In other words, bank lending may be weak but it does not matter because of disintermediation.

The chart below shows the break-down of loans to non-financial corporations. As you can see, the pick-up in total loan growth was mainly contributed by short-term loans and bills.

The chart below shows the monthly change in aggregate financing and the components, a measure which PBOC made up to better measure total funding to the economy. The blue bars are total bank loans in Chinese yuan, and the red bars are foreign currencies loans, which are the name numbers in the regular monetary statistics. The rest are non-bank funding sources.

As you can see, there is an increase in total funding for the economy this year, but the main driver of it does not come from banks. Rather, they are from trust, entrusted loans, and, very notably, corporate bond issuance. Some of the components of this is part of the shadow banking mess which we have been following. While the government appeared to be committed to clean up some of those last year, they are back nevertheless.

Disintermediation, of course, is part of the government’s goal in its 12th five-year plan. However, the fact that the pick up of investments in infrastructure (which are probably part of the “stimulus” to stabilise growth) is not associated with increase in bank loans, but increase in non-bank sources, is curious, to my mind. This is because the government should have most control over credit growth through banks, not through non-bank institutions.

I’ve mentioned before in my guide to China’s monetary policy that if the Chinese government is to stimulate the economy like in 2008/09, they have an “advantage” that the developed world does not have in that they can almost force banks to lend to companies, local governments, Ministry of Railways, etc, so that they can go out and invest. Meanwhile, state-owned banks could be asked to pretend that non-performing loans do not exist, and to extend older loans forever and ever without ever calling them bad. One can argue whether this is a good thing or not for the long-term (think Japan), but at least the government can theoretically maintain stability through such mechanisms in the short-run.

Now, it appears that banks have less appetite to lend. Instead, other components in the total financing of the economy are becoming the main source of funding. In fact, bank loans (Chinese yuan and foreign currencies loans combined) now contribute to slightly less than half of the monthly aggregate financing. Besides bank loans, the two largest sources of funding according to aggregate financing statistics are corporate bond, which accounted for 23% of funding in October, and trust loans, which accounted to 11% of funding.

One might raise issues related to this apparent rise in non-bank sources of funding. WSJ, for instance, raises a few issues regarding the issuance of wealth management products by banks which are in turn being invested in trusts loans and bond market. In effect, banks are offering an alternative to deposit accounts which give higher returns, but the funds are being invested in higher risk products. Banks customers might be buying these products on the assumption that it is guaranteed by banks even though they are not. WSJ also wrote:

The trend marks a distinct transfer of risk from the state (in the form of bank lending) to private investors, and comes at a time when local government finances are in a very bad shape. That’s a bad thing.

WSJ also wrote:

Analysts say that not only have the banks stepped back from taking the primary role in funding local governments’ latest round of infrastructure expansion, but that a portion of funds raised from trusts and bonds has gone toward repaying older bank loans.

In terms of stimulating economic growth, however, we have a different problem in mind. Because the government and/or central bank has the most “control” over credit growth through banks by window guidance and state-directed lending, the shift of the reliance of credit growth from sources which the government has most control to sources which the government presumably has less control is unexpected. In a scenario where the government is committed to stimulating the economy, the ideal scenario, as briefly mentioned above, would be asking banks to lend and delay recognising bad loans, not to move the role of credit creation from banks to something that the government and central has less control.

Such trends in non-bank sources of funding does not make us wonder less regarding the determination of the government to stimulate the economy.