China’s banks have gone on a lending spree in 2009, spurred by a combination of loose monetary policy and a tacit assumption that the central and local governments will cover any losses.
Economists were caught off guard by June’s lending figures, which surged to US$223.94 billion. It was thought the peak had been reached in March, when lending reaching US$276.6 billion, with May’s relatively modest US$97.25 billion an indication that the government was scaling back its efforts.
In total, China’s banks have extended US$1.08 trillion worth of new loans in the first half, far outstripping the US$717.17 billion issued in all of last year.
In the short term, analysts say that these virtually unprecedented lending levels do not threaten the stability of China’s banking sector. The medium-term outlook though is murky. While some fear that a wave of non-performing loans (NPL) could begin surface at the tail end of 2010, others expect continued economic growth and vigilant regulators to keep the sector on an even keel.
"In the short term we think the risk to asset quality is limited," said Yuk Kei Lee, an analyst with Core-Pacific Yamaichi in Hong Kong. He noted that next year could present China’s banks with a more difficult operating environment as the central government may tighten monetary policy.
Royal Bank of Scotland estimates that about half of the loans made this year have gone to infrastructure projects, and analysts generally believe lending growth will slow in the second half of the year, as the lion’s share of these infrastructure loans have already been allocated.
However, there are indications that significant amounts of the funds are bypassing the real economy. In addition to anecdotal evidence cited by market watchers, Wei Jianing, an economist at a cabinet-level think tank, in late June estimated that 20% of the credit issued in the first five months of the year was channeled into equity markets, and that an additional 30% flowed into real estate investments. Wei, who stressed that these findings reflected his personal opinion and not those of the State Council, said this influx of funds could lead to dangerous asset bubbles and rising real estate prices.
As the People’s Bank of China (PBoC) released the June lending figures, it also took short-term steps drain liquidity from the market. On July 8 it issued US$7.3 billion in three-month bills and, notably, an equal amount in one-year paper, the first such issue since November 18. The central bank also withdrew US$1.46 billion from the interbank market, the first time it had done so in three weeks.
J.P. Morgan economist Wang Qian said in a recent report that the action doesn’t amount to a significant shift in monetary policy, but rather a fine-tuning of the current policy. While one can never rule out the possibility of tightening of monetary policy, Beijing remains dubious that the economic recovery has found solid ground and thus will maintain the current "moderately loose" monetary policy through 2009.
Dong Tao, an economist with Credit Suisse in Hong Kong, said in a report that until exports and employment rebound, "Beijing will only resort to fine tuning to adjust the lending structure, instead of aggressively taking liquidity back and raising interest rates."
Standard Chartered economist Stephen Green echoed these sentiments on monetary policy in a recent research note, adding that he expects banks’ reserve requirement ratios – money they must keep in reserve and thus not lend out – to remain stable at 15% this year, though he did not rule out any cuts next year.
While China’s lending spree has raised fears of fresh NPLs in the pipeline, some believe there may be more smoke than fire.
"Despite the surge in credit expansion, we believe the market is over-concerned about the asset quality issue," J.P. Morgan’s Wang said, adding that Chinese banks have improved their risk controls since early 2000, reducing the factors that led to surging NPLs in the 1990s.
But Leo Wah, a vice president and senior analyst with Moody’s in Hong Kong said that much of the NPL writeoffs at China’s banks over the past years have arisen from a recovery of legacy NPLs and as such don’t take into account the potential risks arising from new lending.
"When banks are increasing loan growth aggressively it is difficult to believe that credit quality controls are completely the same as what they had been before," he said. Nonetheless, he believes that China’s banking sector will remain strong in 2009, though he doesn’t expect a return to the triple-digit or even high double-digit profit growth seen in previous years.