China’s Shanghai Interbank Offered Rate (SHIBOR) shot up to a record of 13.44 percent last week as deteriorating loans at rural banks forced panicked short-term borrowing.
Shibor has published daily reference rates since 2006 for wholesale interest rates charged by Chinese banks to other banks for unsecured overnight to one-year money-market loans. Shibor’s median overnight borrowing rate had been averaging about 1.84 percent in June. But the surge to 13.44 percent on June 20 was higher than 8.22 percent in January 2011 at the height of the Global Credit Crisis.
The People’s Bank of China flooded the banking system with 50 billion yuan($7.2 billion) of short-term liquidity to push the overnight rate back to 1 percent. However, Diana Choyleva of Enodo Economics warns that financial distress from China’s growth crunch is building in the non-bank sector in what she warns is a “very slow-motion crisis.”
Enodo points out that the financial markets applauded the Beijing authorities during 2017 and the first half of 2018 for progress in addressing the banking sectors’ mounting bad debt issues through de-risking of speculative economic activity. But the People’s Bank of China’s first quarter monetary report reveals interbank borrowing and lending reached record highs, as wholesale funding has “decidedly reversed” over the last nine months.
At the end of the second quarter of 2015, China rural banks’ average non-performing loan loss reserve coverage was 206.4 percent, slightly better than the 198.4 percent average for all banks. But rural banks’ loan loss reserve coverage began plummeting after the third quarter of 2017 and now stand at 128.5 percent, versus 192.2 percent national average.
The Chinese authorities understand that the export led growth cycle ended with the Global Financial Crisis and China must rebalance towards household spending. But China’s smaller lenders that mostly serve households are the weak link in the strategy.
China encouraged so-called shadow bank lending to skyrocket during the Global Financial Crisis in 2010 and 2011. Shadow bank issuers sold wealth management products to households and then leveraged returns through borrowing from rural bank and the short-term interbank market. The worldwide liquidity crash did slow China’s GDP growth from 15 percent in 2007 to 6 percent in 2009, but GDP roared back to 10 percent growth during 2010 and 2011.
With wealth management products investing mostly in the corporate debt of state-owned enterprise (SOE), the industrial profits rebound from 2010 to 2014 created high returns that drove larger public wealth product sales and greater amounts of rural bank lending.
But as China’s industrial profit growth went negative in 2015 and 2016, many SOEs stopped paying interest and shadow banks had no ability to foreclose on SOE loans. Enodo estimates the four-quarter average industrial profit growth did rebound from 2016 to mid-2017 to 17.3 percent, before plunging to negative -13.5 percent in the last quarter.
As a result of accumulating losses, S&P reported Chinese corporate bond defaults started at just 4 in 2014, but rose to 125 in 2018. More concerning for rural bank lenders, defaults jumped from 25 in the first five months of 2018 to 67 in the first five months of 2019.
With shadow banks not repaying loans, rural banks went from lenders to heavy borrowers in the interbank market. By the end of 2018, Enodo estimates Chinese interbank loans now exceed 1.5 times the China’s official 2018 GDP, or 141.6 trillion yuan ($20.5 trillion).
China interbank lending to small firms has grown by 12 times in four years, a faster growth rate than the United States in the run up to the Global Financial Crisis. But Reuters recently reported: “China’s securities watchdog has told several large non-bank financial institutions to lend in the interbank market to smaller non-bank firms to help ease any cash shortfalls.”
Enodo estimates “system-wide credit losses could reach 20 percent of GDP,” or about 16 trillion yuan ($2.32 trillion), with Chinese banks share at almost 12 trillion yuan ($1.74 trillion).