China’s banking sector faces risks as policymakers seek to tighten credit and asset prices, financial sector leaders, academics and economists have warned.
The Chinese authorities have imposed macroprudential measures to limit bank lending and credit to sectors deemed at risk of overheating over the past 12 months, most notably increasing reserve requirement ratios to a record 20.5%. This has resulted in a slowdown in lending growth so far this year.
Mortgage and credit restrictions have been imposed, aimed at slowing rapid house price growth.
But Charles Dallara, managing director of the Institute of International Finance (IIF), who arrived in Hanoi after visiting China, said on Tuesday that while tightening efforts have had some impact in slowing headline credit growth, they could be storing up long-term problems by forcing borrowers to look outside the conventional banking system.
“Credit is becoming relatively scarce for certain borrowers,” Dallara told Emerging Markets. “Mid-tier corporates, private borrowers and private entrepreneurs are being squeezed by the continued demands for credit by the state sector and by the reserve requirements, which are beginning to bite.
“So you are running a risk of an underground credit market developing. This worries me in the near term because it means that the authorities’ efforts to contain inflation are going to be undermined by China’s own version of a shadow banking system.”
He suggested that the emphasis on reserve requirement ratios and credit controls rather than on interest rates risked exacerbating risks for the sector.
“The problem I see is that the authorities are trying to run a nearly 21st century economy with tools that seem to feel like 1964,” he said.
“If they were to liberalise interest rates and allow the exchange rate to be used more flexibly to reinforce monetary policy then I think we would see a more effective set of macro-economic tools to be used.”
Many economists and academics believe that administrative attempts to control house prices may also prove counter-productive.
Louis Kuijs, senior economist at the World Bank in Beijing, told Emerging Markets: “The government is putting a lot of effort into trying to contain housing prices in a market where the fundamental drivers are likely to continue to increase housing prices over medium-term.
“If tightening were to lead to a significant slowdown in the property sector, because property plays such a large role in the overall economy, if these parts of the economy stutter, this would have a significant impact on the banking sector.”
However, while acknowledging risks from tightening measures and non-performing loans, other academics and economists believe that the government has the means to step in and rescue the banking sector.
Andy Rothman, chief China macro strategist at Asian brokerage and research firm CLSA, said: “Every bank is controlled by CCP, and ultimately if things go wrong, the hit comes on balance sheet of the communist party, not the banks. The Party is in my opinion the world’s most liquid financial institution today, so it will pay the loans and move on.”