Attempts to slow China's spiraling bank loans amid worries of economic overheating will produce mixed results at best, or at worst may add to the nation's growing burden of non-performing loans, a report by influential ratings agency Moody's Investors Service has warned.
The May 7 report said raising rates to slow demand for loans was a "double-edged sword" that, while cooling the economy, might also create asset quality problems for banks and a slow down in earnings.
Moody's warned that authorities may find it difficult to put the brakes on bank lending because of the huge deposit base in Chinese banks and structural factors favoring loan growth.
"FDI [foreign direct investment] inflows and a propensity to save mean a continued build-up in deposits, leading to pressure on the banks to keep lending," the report said.
Different banks would be affected in different ways by the fallout resulting from a rate rise, the report said. China's smaller, fast-growing shareholding and city commercial banks would bear the brunt of any resultant drop in earnings, while the "Big Four" state banks could still be hit but would be less affected. The latter, the report noted, have been more responsive to government calls for slowing loan growth.
Massive bank lending has been the driving force behind China's economic growth in recent years, accounting for 85% of all funds raised last year, according to the People's Bank of China, the country's central bank.
"That such a high portion of economic activities is supported by bank loans raises concerns about the build-up of risk in the banking sector," said the report's author, Moody's vice president, Wei Yen.
Another issue, the report noted, is that while the central government has largely removed its direct involvement in loan decisions, local governments have continued to exert pressure at the branch level, especially when it comes to funding for pet projects and in particular at the smaller city commercial banks.
In the current climate, wrote Yen, the government may need to use further administrative measures to rein in the economy, whether it wants to or not.
"Because loan pricing remains tightly controlled, and market mechanisms are not sufficiently developed to influence the supply and demand of credit, strong administrative measures, though evocative of a planned economy, remain necessary at this stage to provide needed adjustments," Yen wrote.
If the central bank raises base interest rates – unchanged since 2002 at 5.31% – it could slow demand from the fast-growing coastal cities, the report said, but it would also add to pressure on leveraged SOE borrowers and penalize borrowers from less developed regions that are only just beginning to see signs of growth.