2014-02-15

Western Banks Exposed to Chinese Banking System as Shadow Banking System Collapses; China Trust Industry Says Systematic Crisis Impossible

Evidence coming in continues to point to a great contraction in the trust market. 信托月报:新设信托数量规模环比腰斩 收益率下行至8.43%. Trust fundraising fell 50% in January, slightly better than the 60% drop reported last week. The word they use to describe to number of new products translates as "cut in half," but in Chinese this colorful term refers to a method of execution employed by Chinese emperors which involved cutting the body in half at the waist. The word is more appropriate here than the headline writer may realize because if this level of contraction holds up, death indeed may be the ultimate result for many in the trust sector. However, as 50% is better than the 60% drop initially reported, the trend for the trust industry looks to be improving—though we'll know more once February estimates start rolling out.

This chart shows the number of new trusts broken down by type (bars, left axis) and assets (line, right axis). Note the collapse in financial products, the purple bar.


China's Banking Regulatory Commission is building a registration system for trusts: 金融:信托产品登记系统筹建 信托流动性桎梏有望打破. This is expected to help break the liquidity crunch currently facing the industry. A big problem for companies is their guarantee to repay investors. Now that trust failures are beyond the ability of companies to repay, the guarantee is worthless and results in an opaque system where investors have no idea of the trust's true value. It is hoped that the registration system can develop the industry and allow for risk-sharing and intermediary services. At this point this may only serve to uncover the depth of the emerging crisis.

The trust industry itself says a systematic crisis is impossible: 中国金融:信托业协会称信托资产质量优良,不可能发生系统性风险. That's as good as their other guarantees. The article repeats the words of the trust industry: bad assets were only 0.268% of assets in 2012 (no mention of 2013) and there are ¥9 billion in reserves against ¥20 billion in bad assets (based on 2012 figure of ¥7.4 trillion in assets, or 45% of the total. Additionally, the trust industry has ¥255 billion in capital, more than 12 times the problem assets.

The industry wants to focus on the positive. The negative way to view the numbers is as follows: the industry was levered 30 to 1 at the end of 2012. If bad assets grew to 3%, it would consume all of industry's equity. In 2013, the problem got worse because the system became even more highly leveraged. The Chinese banking system has seen non-performing loans much higher than 3%. One must believe the trust industry, which is making bridge loans to real estate developers and highly indebted coal mines, is safer than the Chinese banking system as a whole, which only a few years ago still had NPLs in the high single digits—to say nothing of rates in the double digits during a crisis. A systematic crisis isn't impossible, it is more likely inevitable.

When a crisis does finally erupt, Western banks will not escape the fallout

In Western Banks and China: ‘Interesting Times’ Are Coming, Peter Tenebrarum lays out the risk:
The total exposure of Western banks thus amounts to $709 billion. Australia's banks were a bit late to the game, but sure did their best to catch up quickly, as the 230% increase in their claims since 2011 shows.

In other words, we now have additional evidence of the growing vulnerability of Australia specifically. As we already pointed out in our musings about how “financial contagion” might spread from China in spite of its closed capital account, Australia is a pivotal region. Australia's economy greatly depends on China's commodity imports, and its banks have financed an enormous real estate bubble on the back of the commodities boom.

Moreover, Australia's banking system itself is highly dependent on foreign short term funding sources. Although the chart above doesn't tell us anything about the maturities of the claims on China, we would not be surprised if many or even most of the loans to China had much longer maturities than the foreign funding Australian banks get from (mainly) Europe. The main point is though that we have yet another source of potential trouble for Australia here – the exposure of Australian banks to China amounts to 9% of Australia's GDP at this point.

......In the course of this year, some $800bn. of debt issued by 'wealth management products' is coming due in China, and Mr. Darby notes in this context that the potential knock-on effects on Western banks from an increase in non-performing loans in China are probably not properly appreciated at this juncture.

Especially UK banks with a huge $193 bn. in total exposure, as well as Hong Kong banks (approximately $150 bn. in net claims) and Australia's 'big four' banks seem to be in the line of fire here.

Moreover, we must expect that in the event of a shadow banking crisis in China – a highly probable event given what is known about the practices of the sector and the amount of debt coming due in the near future – will have considerable effects on numerous emerging market economies, especially if China should eventually decide to devalue the yuan (currently the yuan seems quite overvalued actually). In that event, both commodity exporters and exporters of semi-finished and final goods that compete with China would feel the pinch.

This would in turn mean that Western banks would not only have to grapple with a possible rise of NPLs in China itself, but also with an even bigger currency and debt crisis in a number of emerging markets. Since many Western banks remain in weak condition following the 2008 crisis and the euro area debt crisis, they will then be inclined to further reduce their lending in their home countries as well, so as to preserve capital. A vicious cycle could easily be triggered.
See the whole article for a breakdown of country exposure. Western Banks and China: ‘Interesting Times’ Are Coming

I was early in looking for the yuan to devalue; it recently hit new highs near 6 to $1.

Chinese Yuan Could Devalue 50% Or More
Yuan collapse goes mainstream as Financial Times discovers the yuan can drop; exchange rate hyperinflation cometh?

In another post I had linked to an article that no longer exists, but here was the quote I pulled:
Everbright Securities macroeconomic analyst He Yuanyuan found in the fourth quarter of last year and April this year, the central bank bought yuan and dumped foreign currency (expressed as a reduction in the total of foreign currency assets). This shows that China's central bank is in the market to support the RMB exchange rate, to prevent it from excessive devaluation. This shows from another perspective, the pressure of RMB devaluation.
At the end of 2011 and again in April that year, China's foreign reserves dipped slightly and the result was a decline in the value of the yuan.

In Chinese Yuan Could Devalue 50% Or More, a chart of intraday price movements shows that traders have tried taking the yuan lower at other times, but were thwarted by the central bank raising the value of the renminbi (traders can only trade within a band around the fixing). The takeaway is that there has been pressure on the yuan before and even a minuscule drop in reserves led to yuan selling. The central bank has eased control over the currency; moving dollars out of China is possible and there's the offshore renminbi market in Hong Kong. If there is a crisis and China's reserves sink in order to pay for a bailout, the yuan will slide sharply overseas. The reaction of Chinese citizens will be to pull dollars out of China and sell them in Hong Kong (or simply hoard them). As we saw last spring when Fake Exports Caused The Yuan Rally, Chinese have many creative ways of getting around capital controls.

The obvious solution for export juggernaut China, with an overvalued property market and a credit bubble, is for the currency to devalue. This will help exporters, deflate the property market (in terms of real value) and solve any credit contraction. It was used by nations to get out of the Depression—the U.S. devalued the dollar by 40% against gold in 1934 (gold gained 75% against the dollar). And at the time, the U.S. had huge reserves, much as China does today, yet it still went through a major devaluation.


Source: Central Bank Gold Reserves: An historical perspective since 1845

No comments:

Post a Comment