Senior bankers are looking on the bright side of last month’s clampdown by China on the shadow-banking sector, saying it underscores Beijing’s newfound enthusiasm for rebalancing and liberalizing the economy.
Bankers struck a bullish note on the volatility, citing the upside to the newly aggressive regulatory stance as Beijing adopts a twin strategy of forcing lenders to improve liquidity and asset-liability-matching practices in the short term while paving the way for greater financial liberalization.
"The small banks were getting too aggressive in their activities with trust companies and in the shadow-banking system, more generally," says Jaspal Bindra, Standard Chartered’s chief executive for Asia. "The Chinese authorities provided a message to these players: don’t take the liquidity for granted and you can only take leverage to a point."
The PBoC’s rare, though short-lived, tolerance for volatile money-market rates underscores its commitment to liberal reforms, says Bindra. However, markets are likely to take fright in the process, given the lack of policy transparency, as the PBoC needs to constrain credit growth to private lenders without abruptly repricing the large liability base of heavily controlled state lenders, he says.
Sustainability
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| Jaspal Bindra, Standard Chartered’s chief executive for Asia |
Bindra adds: "The question is: could they have done it in a more gradual way over a sustained period? In any case, the Chinese authorities achieved their goals, and we are not talking about large insolvencies – this is more about fears that returns on investments will be impaired over time. Clearly, the Chinese government is caught in a dilemma: they want sufficient credit out there but they want that credit expansion to be prudent."
Jonathan Larsen, head of retail banking at Citi, adds: "I don’t like this shadow-banking system – it’s like an unregulated mutual fund. But the likelihood of this spinning out of control is low. The banking system is well capitalized. And the good thing about China is that they understand this [shadow-banking system and imbalanced growth model] is a problem. The authorities will find the right balance between reform and growth."
China’s economic model – top-down monetary management, artificially low interest rates and a closed financial system – has ensured the structural growth of higher-interest-bearing products in the informal banking sector as savers seek shelter from financial repression. While global market volatility underscores the stabilizing benefits of financial protectionism, market players argue that the engineered liquidity crunch highlights how Beijing is eyeing faster-than-expected economic reforms, particularly interest rate liberalization, a prerequisite for capital-account liberalization.
Jan Dehn, head of research at emerging markets specialist Ashmore Investment Management, says: "This liquidity crisis is bullish for China reforms", citing Beijing’s growing acceptance of slower economic growth to reduce distortions, the systemic benefits of restricting credit growth to riskier borrowers and the opportunity to experiment with volatile and tighter money-market rates.
The counterpoint comes from Michael Pettis, the famed bear, who wrote last month that the political and economic cost of higher interest rates – exposing the indiscipline of state-backed borrowers, in particular – coupled with the new normal of diminishing returns of China’s investment-led growth, will sow the seeds of a growth crisis. Pettis, who previously argued that the growth of the shadow-banking system would reduce the likelihood of financial liberalization by underscoring the systemic risks of innovation, said: "It’s likely that the days of the super-powered Chinese economy are over. Instead, Beijing must content itself with grinding its way through the debt that has accumulated over the past decade."
Underscoring the sharply divided opinion about China’s road to reform, Bindra concludes: "The Chinese do have an understanding of what they need to do; they just need to get the timing and policy balance right. We are not worried about a credit blow-up in China. We think China does not get enough credit for its strategic successes. Will they get something wrong in this process? Probably."
Sovereign risk
Amid the liquidity concerns, China’s banking sector is now the principal source of sovereign risk, reversing a decade-long trend, according to analysts.
The markets appear to agree: CDS spreads of Chinese banks soared by an average of 79 basis points in June.
Allan Dwyer, professor of finance at Mount Royal University, Canada, says: "The central bank officials in China are still learning the game, that the policies taken in one sector of the system can have a dramatic – and negative effect – in other areas."
Janis Hübner, emerging markets economist at DekaBank and a Euromoney Country Risk expert reckons liquidity conditions and a more prudent monetary policy could ignite a steeper slowdown in economic growth in the longer-run. "We might see slower credit growth, especially in the shadow banking sector, and all this will weigh negatively on growth, which means we might see a steeper slowdown in growth than we expected."