Where is the Chinese Banking System heading? Some take-aways for Europe

Transcription

1 Where is the Chinese Banking System heading? Some take-aways for Europe Alicia Garcia Herrero Senior Fellow, Bruegel May 218

2 Key issues 1. China s financial sector in context 2. China s first wave of bank reform 3. Banks to China s rescue in the wake of the global financial crisis 4. Hitting the wall again and the new restructuring wave 5. The way forward and consequences for Europe 2

3 1. China s financial sector in context 3

4 China s economy is not only huge already but will continue to contribute much more than any other large economy to global growth: Increasingly large spillovers on rest of the world Change Contribution to world growth (USD tr, %) (21%) 9.4 (1%) 4.6 (6%) Current Size (215) Source: Natixis China US Europe 2 4

5 China Korea India Japan EU Australia Canada US Brazil Japan Canada Euro Area China US Australia Korea Brazil India Supported by massive (and captive) savings, China s financial deepening has been even faster than the growth miracle but less attention is paid as to how it has happened 5 Saving Rate in 216 (%) 4 Credit to GDP in 217 Q3 (% of GDP) Sources: Natixis, World Bank *Credit to GDP is calculated as sum of credit to general government, household, corporate to GDP Sources: Natixis, BIS 5

6 The backbone of China s financial system is the banking sector with assets as large as those of EU banks already but coming from a very small base in 25 5 Europe 5 China 5 US Bank Assets Market Cap Bond Bank Assets Market Cap Bond Bank Assets Market Cap Bond N.B. Unit is USD tn. Bonds is till of 217 Q3 Europe included euro area, UK, Sweden, Switzerland, Norway, Denmark Source: Natixis, BIS, Bloomberg 6

7 Total Private Credit (US$ tr) However, China s GDP per capita is still only one third of that of Europe so financial deepening set to continue with a multiplying effect on the absolute size of China s financial assets Total private credit and GDP per capita China (217) Europe (217) Europe (25) China (25) 1, 2, 3, 4, GDP/capita (Current US$) N.B. GDP per capita of Europe is in 216 Source: Natixis, BIS, CEIC, Datastream 7

8 China Singapore Switzerland Canada Japan Indonesia Colombia Chile Thailand Mexico Turkey Argentina Saudi Arabia France Malaysia Czech Republic Norway Korea Germany South Africa Russia Finland Poland Brazil United States India Australia Israel Austria Belgium Sweden Euro area The problem, though, is that China s financial sector is already stretched due to China s investment led growth model leading to very low return on assets and a very high credit gap 2 15 Credit to GDP Gap, 217 (In percent) 4 Return on Assets (%) N.B. Credit-to-GDP gaps is based on total credit to the private non-financial sector, as % of GDP Source: Natixis, BIS (217 Q3) JP TH ID US KR PH TW VN IN SG MY UK AU DE CN FR *Estimated from stock indexes as of Q1 218 Sources: Natixis, Bloomberg 8

9 Most importantly, the use of bank credit to support an investment-led growth model has been government driven as the intermediaries (i.e., the banks) continue to be generally state-owned Proportion of total asset by banks (%) 1 SOCB JSCB CCB RCB Policy Banks Others *RCB is included to others until 213. Since 214, RCB is counted separately from others. Others include foreign banks, postal savings banks, non-bank financial institutions. We estimated the value of asset value of policy banks Source: Natixis, CBRC 9

10 2. China s first wave of bank reform 1

11 The banking sector was instrumental in Zhu Rongji s SOE restructuring but at the cost of a massive clean-up in the early 2s After institutional shake-up: From mono bank to sectoral banks To the separation of commercial and policy banks (1995) To reinforcement of the PBoC charter (with bank supervision/ payment functions) Bank restructuring starts: Public funds injected to recapitalize state-owned commercial banks (SOCBs) Non-performing loans (NPLs) divested into newly created Asset management companies (AMCs) But also private funds (first strategic investors and then IPPs in Hong Kong and, alter also Shanghai Government control of banking sector remains intact: private funding to reduce cost of restructuring and import best practices but never to divest control To support the restructuring efforts, the process of financial liberalization slows downs (relative to rest of economy) and financial regulation remains accommodative 11

12 Several government agencies involved in restructuring process but still centralized 12

13 Estimated total cost of first waves around 24% of 24 GDP with a very large reduction in banks NPL ratio. But a good part of the cost hidden in AMCs which only managed to recover around 1% of transferred NPLs with a latent loss 13

14 A way to reduce the cost of restructuring was to keep financial representation and regulatory forbearance. Very low interest rates are the best example of the former Sources: Haver Analytics 14

15 3. Banks to China s rescue in the wake of the global financial crisis 15

16 The largest credit binge in recent history The global financial crisis, with a massive immediate effect on China s export orders and, thus, manufacturing unemployment, was a clear wake-up call for China to shift its growth model to domestic demand. The urgency of the response needed shifted the model to investment (consumption being slower to react). Banks were instrumental in carrying out the government massive stimulus package though credit targets to be achieved on lending to local governments for infrastructure projects as well as SOEs for their investment plans. This led to an extraordinary expansion of banks balance sheets and ballooning credit growth 16

17 Beyond PBoC window guidance to boost credit and very lax monetary policy, China attracted massive capital inflows which added to the credit binge. This was not only reflected in bank asset growth but, even more so, in the shadow banking. Most of the credit went to corporations but also local governments 4% 35% Nominal GDP, Total social financing and Bank Asset Growth Bank asset GDP TSF 3% Credit to GDP Non-financial corporations Goverrnment Households 3% 25% 25% 2% 2% 15% 1% 5% 15% 1% 5% % % N.B. Total social financing is comprised of a total of loans, shadow banking, equity and bonds, which is provided by PBoC Source: Natixis, Bloomberg Source: Natixis, BIS * Year 217 end day: 9/3/217 17

18 Beyond bank assets, both bond issuance and shadow banking have surged since GFC but both closely intervened with banking sector: Banks have long been largest issuers of wealth management products (part of shadow banking) Size of WMP by Industry (RMB tr) China total social financing (RMB tn) Shadow Banking Bonds Loans Share of Shadowbanking (%, rhs) 2 Banks Trust Fund Co. Securities Co Insurance Private Equity Sources: Natixis, CEIC Source: Natixis, CEIC 18

19 Corporates leverage facilitated by China s very fast growth as a consequence of lax financial conditions after GFC, leading to a rapid increase in profits. Also banks asset quality improved on the back of massive credit growth 18 China Corporate Debt (USD bn) Corporate Debt (% of GDP) Industrial Porfit Growth (%YoY, rhs) Stressed Loan Ratio (%) Non-performing Loan Stressed Loan Sources: Natixis, CEIC Stressed loan is the sum of non-performing loan and special mention loan Source: Natixis, WIND 19

20 Banks remained largely exposed to the corporate sector (also to local governments) but their compliance with seemingly tight regulation of 15% minimum coverage ratio seemed enough to avoid solvency problems down the road Asset by Sector of Average from (%) NPL Coverage Ratio and Provision Loan Loss Provision (RMB bn) Others, 18.8 Corporates, 37.8 Household, 13.8 Non-bank FI, 8.6 Bank, 15 Government, 6 4, 3,5 3, 2,5 2, 1,5 1, 5 NPL Coverage Ratio (%, rhs) Regulatory Requirement Sources: Natixis, CEIC Source: Natixis, WIND 2

21 4. Hitting the wall again and the new restructuring wave 21

22 After being freezed during GFC, financial liberalization accelerated between

23 Interest rate liberalization and heightened competition from more private banks, led to a reduction in the interest margin, pushing return on assets/equity down the road Return on equity and return on asset (%) Return on Equity Return on Asset (rhs) Source: Natixis, WIND Net Interest Margin (%) Source: Natixis, WIND 23

24 Collapse in industrial profits since 212 and worsened environment and asset quality, pushing ROE even lower. Bank efforts to cut costs were not enough to offset impact of worsening asset quality Loans Write-offs Cost to income Ratio (%) Loan Write-offs (RMB bn) Loan Write-offs/Total Loan (%, rhs) Source: Natixis, Bloomberg N.B. Data of listed banks used Sources: Natixis, WIND 24

25 Bank solvency was not severely affected thanks to an easier access to market (from booming onshore bond market in China) Onshore Bond Issuance of Commercial Banks (RMb bn) 1, Source: Natixis, WIND 25

26 But, seemingly ample capital casts worse asset quality that recognized in NPL ratio as well as large (non-consolidated) offbalance sheet assets Financial Leverage of Chinese Banks Asset-to-Equity Ratio Adjusted Asset-to-Equity Ratio Adjusted ratio calculated by using the sum of asset and wealkth management products divided by equity Source: Natixis, CEIC Stressed Loan Coverage Ratio (%) Source: Natixis, WIND 26

27 The new wave of restructuring after GFC has had to main components to address the two key sources of bad assets Focused on two key problems generated by credit boom: Bank loans granted to local governments (directly or through special vehicles) Bank loans to corporates with overcapacity (mainly in the industrial, up stream, sector) 27

28 The clean-up of local governments seems to have come to an end, which has improved bank solvency but has also reduced profitability Local Government Debt Swap Local Government Debt Swap (RMB bn) % of GDP 7, 7% 6, 5, 4, 4% 4% 3, 5,484 2, 3,32 3,25 1, Source: Natixis, WIND 8% 7% 6% 5% 4% 3% 2% 1% % Local Government Yield Before and After Swap (%) Original* *Average loan interest rate before debt swap mentioned by government officials Source: Natixis, WIND 28

29 Moving to corporate problem loans, the clean-up started with the use of debt-to-equity swaps but there is still a long way to go to clean up all of the problem assets (between 15-2% achieved) and so far only target over-capacity SOEs Announced Debt to Equity Swap (RMB bn) Announced Deals (RMB bn) % of Total Loans (rhs) 1, , Source: Natixis NB Based on swap announced date Implemented D/E swaps remain limited (Value, % of Total Announced Deals) Not-implemented 884 RMB bn, 84.3% Data as of 5th Feb 218 Source: Natixis Implemented 165 RMB bn, 15.7% 29

30 From the first (naive) approach to keep the equity in the banks, divestment of both loans and equity from banks to rest of financial system was preferred: Banks as big winners (but only SOCBs);Potential risks for insurance and asset management companies (AMCs);Another venue for disposal of assets is AMCs, more recently also created by banks Debt-to-equity Swaps by Investor (%) Registered capital of Asset Management Companies by Group (RMb bn) Banks (mostly through their own AMCs), 4 Private equity funds, 5 State-owned funds, 27 Insurance Companies, 3 Asset management companies (AMCs), 34 Aluminum Corporation of China, China State Shipbuilding Corporation and China Shipbuilding Industry Company included Source: Natixis Banks' AMC Local AMC Country Level AMC Source: Natixis 3

31 In addition, more market driven securitization of loans also in full swing, to create more lending space in banks balance sheets Outstanding Asset Backed Securities (RMB bn) RMB bn % of Total Loans (rhs) 4, 3,5 3, 2,5 2, 1,5 1, Source: Natixis, WIND Outstanding ABS by underlying asset (217) Credit Card Loans, 5% Others, 22% Beneficial rights of trust, 5% Auot Loans, 6% Source: Natixis, WIND Rental, 8% Receivables, 8% Corporate loans, 25% Mortgage loans, 11% Consumer loans, 1% 31

32 In a nutshell, the ongoing bank restructuring uses quite different tools but also state-owned driven First Round ( ) Second Round (215 - Now) Key Methods Capital injection Debt-to-equity swaps Disposal of assets Securitization IPOs Onshore and offshore bond funding Capital from government Yes No Centralized approach Yes No Market force No Semi 32

33 5. The way forward and potential implications for Europe 33

34 Opening to financial institutions?: to share the burden? Foreign institutions might not be so interested Market Share of Foreign Capitals in China (%) Funds Life Insuers Securities Banks Joint Ventures Solely Owned Cost and Income of Chinese and Foreign Banks in China Cost to Income Ratio (%) Chinese Banks Return on Asset (%, rhs) Foreign Banks N.B. Data as of 217 except for fund which is based on 216. Asset size used for banks. Operating income used for securities. Premium used for life insurance. Net Income used for fund. Source: Natixis, Company Data, CEIC, WIND N.B. Data as of 217 except for cost to income ratio for foreign banks, which is estimated by the median value of avaiable disclosure as of 216. Source: Natixis, CEIC, Company Data 34

35 Chinese banks have also expanded their overseas strategy as a way to diversify Overseas Loans 7, Oversea Loans (RMB bn) % of Oversea Loans to Total Loans (rhs) 8 6, 5, 4, 3, 2, 4, , , , 1 Source: Natixis, Company Data f 35

36 Regulatory forbearance being reduced but still helping and no reduction in pervasive role of state Chinese regulator dragging its feet to introduce TLAC Single regulator for asset management industry announced but with implementation delayed again to 22 Monetary policy laxer again No intention to reduce the size of the state in the financial system 36

37 What is it in for Europe Chinese banks, especially state-owned banks, will be reinforced from current clean-up Do not expect a financial crisis in China soon If anything, they will become even bigger from consolidation efforts to address problems in smaller banks Their going-on strategy increasingly relevant for China s Belt and Road Initiative European banks to face increasing competition in third markets and, for Chinese corporates, also in Europe 37

38 Thank you!