Deleveraging Campaign Starves Smaller Banks of Funds

China’s heavy-handed deleveraging campaign is hampering the prospects of smaller lenders by stymieing their ability to access funds via the interbank market.

Lacking the extensive branch networks of the big state-owned banks, smaller Chinese banks have long been dependent upon interbank borrowing to fund operations.

This dependence has spurred the rise to prominence of the interbank negotiable certificate of deposit, as key means for the bigger banks to channel funds to their smaller sized peers.

In the four years following their launch the total issuance of negotiable certificates of deposit on China’s interbank market surged to 20 trillion yuan, or nearly twice the size of national GDP.

The rise of NCD’s was heavily expedited by the fact that they are not categorised as interbank liabilities, for which there is a ceiling of one third of total liabilities.

This meant that smaller banks had carte blanche to use them as a means of borrowing from the big incumbents.

The sudden boom in interbank NCD’s has raised the hackles of regulators amidst their ongoing deleveraging campaign, which is directed at China’s burgeoning debt pile and associated systemic financial risk.

Regulator have introduced new rules requiring that banks obtain pre-approval for NCD issuance, as well as placed a ceiling on issuance volumes.

Reuters reports that the regulatory changes are already hampering the fortunes of smaller Chinese banks, such as Bank of Jilin and Baoshang Bank, compelling them to make changes to a business model that has relied heavily upon short-term borrowing via the interbank market.

Bank of Jilin’s issuance of NCD’s surged to 108 billion yuan in 2017 from 21.3 billion yuan in 2015, the year that it opened up an office in Shanghai to foster interbank cooperation.

Baoshang Bank’s interbank borrowings, which include NCD’s comprised 48% of total liabilities as of the end of the third quarter of 2017, as compared to a cap of 33%.

“The smaller (banks) will have a difficult time…even if they can manage to increase their loan book,” said Gary Ng, Natixis economist in Hong Kong to Reuters.

The squeeze on interbank CD’s is compelling some banks to turn to the bond market for funding, resulting in a leap in their issuance of convertible and subordinated debt in 2017, while also potentially crowding out other companies.

Arthur Lau, co-head of emerging markets fixed income and head of Asia ex-Japan fixed income at PineBridge Investment, said that the Chinese central bank is showing greater tolerance for smaller banks to weather financial difficulty.

Lau does not consider outright defaults to be a likely outcome, however, and instead expects healthier banks to be asked to take over any moribund lenders, in order to avert systemic risk.

 

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