China‘s Banking Sector

Old Problems Overcome – New Problems Ahead

Conference on European Economic Integration (CEEI) 2011

“European Integration in a Global Economic Setting – China, Russia and CESEE”

Vienna, 22 November 2011

Markus Taube

2

Storyline

I. State of the Chinese Economy

II. Banking Sector Development

III. Risk Assessment: The Real Estate „Bubble“

IV. Shadow Banking

V. The Way Ahead

3

Storyline

I. State of the Chinese Economy

II. Banking Sector Development

III. Risk Assessment: The Real Estate „Bubble“

IV. Shadow Banking

V. The Way Ahead

4

Slowing but still strong growth

Contribution to GDP growth%, annual average

10,610,1

9,0

6,86,2

7,9

9,1

10,7

11,5

10,3

9,29,8 9,7 9,5

9,1

0

2

4

6

8

10

12

14

1. Q 2008

2. Q 2008

3. Q 2008

4. Q 2008

1. Q 2009

2. Q 2009

3. Q 2009

4. Q 2009

1. Q 2010

2. Q 2010

3. Q 2010

4. Q 2010

1. Q 2011

2. Q 2011

3. Q 2011

GDP growth%, quarterly, yoy

NBS 2011, IMF 2011

5

Private investors are back

Fixed Asset Investment, yoy growth

IMF 2011

6

Strong exports and increasingly dynamic import activity

Trade Development, monthly, US$ billion

IMF 2011

7

-4

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6

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Overall CPI y-o-y Urban CPI y-o-y Rural CPI y-o-y

Inflation is coming down

NBS 2011

CCB Int‘l 2011

8

Money supply and formal sector loans back to normal

0

5

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M2, yoy

0%

5%

10%

15%

20%

25%

30%

35%

40%

0

10000

20000

30000

40000

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Mrd

. Y

ua

n

Total loans Change y-o-y

RMB loans

of financial institutions

CBRC 2011

Bloomberg 2011

9

Storyline

I. State of the Chinese Economy

II. Banking Sector Development

III. Risk Assessment: The Real Estate „Bubble“

IV. Shadow Banking

V. The Way Ahead

10

China‘s banking system

Increasing diversity,

but still dominated by the big-4IMF 2011

11

The ‘old’ problems are gone

The problem of NPLs

appears to have been

overcome

– and it remains an SOCB

issue.

0

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NPL ratio in %

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

0

500

1000

1500

2000

2500

01

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Mrd

. Y

ua

n

Total NPL (right) Share of SOCBs (left)

Total NPL and share of SOCB

(left) (right)CBRC 2011

Bloomberg 2011

12

Substantially strengthend, impressive crisis resistance

Thanks to the substantial decline of their NPL burden as well as strengthend

equity capital positions all banks would withstand a NPL-quadrupling crisis

upholding capital adequacy ratios of more than the required 8%.

IMF 2011

13

Post-crisis tightened monetary policy

With inflation coming down and GDP growth slowing down

China‘s monetary policy may have reached a turning point

allowing for a loosening of policies in the next months

– liquidity spillovers in the informal sector are to be prevented CBRC 2011

IMF 2011

14

Storyline

I. State of the Chinese Economy

II. Banking Sector Development

III. Risk Assessment: The Real Estate „Bubble“

IV. Shadow Banking

V. The Way Ahead

15

A bubble?

Residential housing100 = Dec 2006, sa

Housing affordabilityPrice-to-income ratio

IMF 2011

16

Local bubbles

Property Prices1000 Y RMB,/s.qm., sa, 3mma

Commercial Real Estate1000 Y RMB,/s.qm.

IMF 2011

17

Banking sector exposure

Real Estate Lendingquarterly

IMF 2011

Mortgage Loansyearly

Hovering on a high plateau ,

formal sector (!) real estate lending

has recently leveled off.

Informal inflows in the sector are

understood to have remained high.

18

Fighting fire with fire – and more …

Social housing in the 12th 5YP:

� Construction respectively renovation of 35 million housing units

� Provision of social housing for 20% of urban population from 7%

end of 2010

� 35% of all housing construction starts in 2011 based on government

housing initiatives

Additional measures:

− Increased downpayment-requirements for mortgage loans

− Higher interest rates (in general and depending on type of investment)

− Restrictive authorization procedures for purchase of 2nd and 3rd apartments

− Restrictive authorization of purchase requests by non-locals

− Real estate tax (pilot project in Shanghai und Chongqing)

− Charging of business tax for real estate resold during first 5 years after purchase

− Binding commitment of local governments to enforce price targets

(maximum price increases per year coupled to disposable income development)

19

Storyline

I. State of the Chinese Economy

II. Banking Sector Development

III. Risk Assessment: The Real Estate „Bubble“

IV. Shadow Banking

V. The Way Ahead

20

20

Global Financial System

Transaction-based

ChineseInformal Lending

Channels

Chinese Formal Financial System

Transaction-based

Additional dimension of financialinteraction – May serve as back-up in case of formal dis-intermediation(liquidity crunch)

Better equipped to serve the specificfinance requirements of the Chinese ‚start-up economy‘ (!?)

More than there seems to be

21

Negative real interest on savings accounts

1-year household savings deposit rate

0,0

0,5

1,0

1,5

2,0

2,5

3,0

3,5

4,0

4,5

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CPI – overall

Negative real interest rates

on savings accounts in the formal sector

continue to drive savers into the

(informal) shadow banking sector,

draining the formal financial system

of resources

22

The ‘formal‘ shadow banking sector

Trillion

Y RMB

PBOC 2011

China Economic

Watch 2011

*

*

“Social Finance”-Concept of NBS, * No shadow banking

23

The informal dimension of Chinese banking

hard information soft information

third party enforcement

‘Transaction-based lending’.

Standard object of analysis in the law,

finance & growth literature.

Standardized information regimecombined with highly formalized

universalistic legal system.

History (reputation) plays is

– in principle – of no importance.

‘Relationship lending’ of the law, finance

& growth literature. The evaluation of

potential financial transactions is

primarily based on information gathered by informal institutional arrangements (-> History rules!). Ensuing financial

transaction are embedded in formal justiciable contractual relations.

second party enforcement

Requires close relationship between

transaction partners in order to

facilitate property rights enforcement

inside a social network and without

recourse to an external ‘umpire’. Given

this close relationship hard information

can be expected to be systemically

less important than soft information for

most financial transactions.

-> Low empirical value: hostage

giving, pawnbroker

Obstacles to co-operation like adverse

selection and ex-post opportunism, i.e.

property rights enforcement, are solved

by informal mechanisms, first of all

social networks based on particu-

laristic ordering regimes. Information

required to make financing decisions is

gathered in non-standardized form in

the context of the underlying social

network by means of frequent and

multiplex interaction.

-> History rules!

24

Specific forms of China’s ‘shadow banking sector’

‘Formal’ Shadow Banking

− Off-balance-sheet lending

− Special Purpose Vehicle

lending

− Direct company-to-company

lending

− Trust companies / Wealth

management organizations

− Leasing companies

− Regulated pawnshops

− Loan guarantee companies

− Small loan companies /

microfinance organizations

− Offshore borrowing

− Private equity organizations

‘Informal’ Financial Intermediation

− Underground banks

− Private money houses

− Associations for mutual assistance

− Rotating savings and credit

corporations (ROSCA)

− Private peer-to-peer lending

− Unregulated pawnshops

− Unauthorized offshore borrowing

Total volume of ‘formal’ plus ‘informal’

shadow banking unknown,

but probably in the range of a minimum

20 trillion annual flow.

25

Storyline

I. State of the Chinese Economy

II. Banking Sector Development

III. Risk Assessment: The Real Estate „Bubble“

IV. Shadow Banking

V. The Way Ahead

26

Three major issues to look at

Property bubble

Are government policies adequate

and can they be fast enough to

deflate local bubbles

Political economy

Can the reform momentum be

upheld in the run up to China’s

leadership change in 2012/13

Shadow banking

Government must separately

address two types of shadow

banking

2727

University of Duisburg-Essen

Mercator School of Management

IN-EAST, Institute for East Asian Studies

Chair for the East Asian Economy / China

Prof. Dr. Markus Taube

markus.taube@uni-due.de