After trebling in size since 2008, China’s credit market is seeing slower growth, but is still expanding twice as fast as nominal GDP – and that’s not sustainable. So argues Charlene Chu, senior partner of UK firm Autonomous Research.
Tighter regulation of the finance sector is needed, added Chu, who does not see “any long-term investment rationale” for mainland banks for the next few years for various reasons.
Chinese banks' assets grew to $28 billion from $9 billion just six years ago, a jump in scale never seen in any economy, she said. While that growth is expected to fall to around 15% this year from 17% in 2014, nominal GDP growth – which Autonomous uses rather than the official data – is also tipped to slow, to 7.8% for 2015, down from 8-9% last year.
To put that in perspective, the US banking sector is about $15 trillion in size, and growth of aggregate banking assets across most major markets has been close to zero since 2008, noted Chu.
She joined Autonomous last year to run the new Asian business. She plans to hire more staff in the next few months to add to her five-strong team.
“We have very serious asset-quality problems in China, and the best signal we have of that is the accumulation of credit itself,” said Chu. Some 40-50% of credit is maturing each year, she added, but banks are essentially rolling over most existing outstanding credit, and extending credit over and above that.
What’s more, more than half of new credit and nearly 40% of existing credit is sitting outside loan portfolios, said Chu. “And we’ve no idea what the quality of assets is on all that other stuff."
“There are huge problems already emerging and GDP is still growing at an 8-9% nominal rate. Think about all the problems that will emerge as growth continues to slow for the next few years.”
And any crash would likely have a regional if not global impact. The $19 billion influx of money in China is “seeping into” every asset class in Asia and beyond, said Chu. “I don’t think any economy would be unscathed if there were a problem in China."
As for the country’s shadow-banking sector, "there is an aspect related to SME financing, but in my view it is more about refinancing existing credit and hiding assets”, she argued. Assets have been “informally securitised” off balance sheet and often wrapped into so-called wealth management and trust products in China from 2009 onwards.
However, more regulation and disclosure is needed around this activity, said Chu. “People would be less nervous about it if there were more transparency. Everyone knows the shadow banking sectors is big and growing rapidly, but we have hardly any numbers to really dig down into it.”
All that said, the Chinese government is reform-oriented and has strong influence over both borrowers and lenders, as well as substantial resources to provide support to the financial sector, including a lot of scope to cut interest rates, noted Chu. “They’re not against the wall yet."
But only when healthier growth independent of credit is achieved and meaningful regulation is put in place is it likely that the credit-GDP growth balance will become more sustainable, she said.
The Hong Kong branch of Autonomous has started out focusing solely on Chinese banks – rather than seeking to cover all countries and sectors in Asia – but aims to expand coverage to other financial institutions, with insurers at the top of the list. Hence the intention to add headcount this year.