As the FT points out, the business model used by the big Chinese banks is to take in deposits from companies and citizens with very few other investment options and then lend the money to large state-backed borrowers at a higher rate of interest.
"This business model is often referred to in China as ‘eating capital’ because it encourages banks to lend as much as they can until their balance sheets are eroded and they have to return to the capital markets for funds in order to meet regulatory requirements," the FT points out, drily.
Of course, China’s bustling economy has put worries about bank capitalisations and bad debts to one side. The situation is relatively benign at the moment. However, Moody’s, the credit rating agency, has made a stand about a particularly odd bit of business – a recent 54 billion yuan ($790 million) cash call on the interbank market by CIC, the sovereign wealth fund.
The purpose of the fund-raising, it seems, was to provide additional capital to three state-owned banks, as well as a policy lender and an insurance company. Hmm. That sounds like China is using debt bought by other banks to recapitalize the worsening loanbook on the banks asset side.
As Moody’s points out: "The increases in assets and equity are artificial and without real economic substance […] Recapitalizing banks with bond proceeds from banks is credit negative because it increases the effective leverage of the banking system. The transaction’s impact on the system is limited in this case because the increased leverage is not significant, but it would be problematic if effective leverage continues to increase and China’s economic growth stalls."