For all the fear of whether French, German, and US banks are solvent, I mean, need to raise more capital, Chinese banks have thus far escaped discussion. It may seem an odd conversation to have for some given many are coming off record profits. Actually, the record profits are a trigger to start to look for trouble. When you look around the corner, one sees a wave of non performing loans coming to market as a result of forced loans to government favored companies combined with a coming bust in residential and office real estate.
The book Red Capitalism captured the essence of Chinese banks.
Commercial banks controlled by the government hold more than 90 percent of China’s domestic financial assets. The government, not a financial market, also decides both lending and deposit interest rates and broadly instructs the banks to lend to favored sectors. In short, [Chinese] banks are passive entities that absorb all the credit, interest and market risk involved in the government’s policy decisions. If, for example, inflation were to grow rapidly, the value of existing bank assets would be decreased.
Alarm bells should be going off. Efficient government spending is a conflict in terms. The pattern has been for Chinese banks go to the market to raise capital from foreigners, transfer that capital to government controlled companies or projects, and when the loans inevitably go bad, the government hides the bad loans in some off balance sheet entity. Then, the banks go back to foreign investors and ask for more.
What happens if foreign investors are unwilling to be the sacrificial lamb yet again, perhaps spooked by a bankruptcy at a major Chinese firm?
The risk is then transferred back to the sovereign entity, which is why the Chinese CDS are up 80%
From Market watch :
- The northeastern province of Liaoning defaulted on about 85% of debt service payments last year, citing a government audit
- China Merchant’s Bank Ma Weihua, warned that China’s banks cannot keep tapping the stock market to fund growth or comply with regulatory demands governing their capital base.
- Life insurers are likely to also need capital
- If investors are unwilling to cough up new funding, there are other options — cut the cash dividend payment, slow down the rate of growth or show a substantial improvement in profitability. Most of these come under the label “hard to do.”
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