Worried about Chinese banks? Pfiff.
Standard Chartered has some intriguing reasons why you don’t need to be – all revolving around the strength of the banks’ sovereign backer, the People’s Republic of China. Perhaps you’ve heard of it?
Here’s what SC say, emphasis and links ours:
Concerns that excessive bank lending in China in recent months (particularly against property) may have set the stage for the bursting of an asset bubble could also a drag on sentiment and limit market gains. However, if past experience is anything to go by, the Chinese authorities have an arsenal of tools at their disposal to deal with potential NPL problems arising from a future decline in asset prices. In the aftermath of the Asian crisis, the authorities set up a number of asset management companies to deal with NPLs [non-performing loans] at the ‘Big 4’ commercial banks and moved NPLs off of banks’ balance sheets in exchange for a mix of bonds and cash. China’s monetary authorities could implement similar measures to deal with an increase in NPLs in the future. Furthermore, FX reserves could be directly injected into banks’ balance sheets (in exchange for shares issued to the People’s Bank of China) in order to recapitalise the banks and reduce NPLs. Thus, while short-term concerns about China’s economy may contribute to short-term market weakness, the longer-term prognosis for China remains robust.
China’s foreign currency reserves are the stuff of many a bank’s dreams. They currently hover around $2,399bn — but there’s some debate as to their actual — practical — use.
The below, for instance, is from China-expert Michael Pettis:
China’s reserves are often thought of as if they were a treasure trove available for spending. They are not. They are simply the asset side of the mismatched balance sheet. If the PBoC wanted to “spend” $100, say for example to recapitalize a bank, it could do so, but this would automatically create a $100 dollar hole in its balance sheet. – it would still owe the RMB that it borrowed originally to purchase the $100. To put it another way, the reserves are not a savings account, free for the PBoC to spend as it likes. Reserves are effectively borrowed money.
The idea here is that because of China’s pegged currency regime, if the Republic wants to operate a current account surplus, it needs to accumulate net foreign claims by the same amount. To finance these purchases it needs to borrow from the domestic market, sell bills, etc.
So according to Pettis, China basically has a balance sheet with foreign assets on the one side, and renminbi-denominated liabilities on the other side. To avoid an asset-liability mismatch it needs to keep those things equivalent – China cannot spend its FX reserves without increasing its net debt.
Recapitalising banks via reserves would therefore be a fairly circular exercise — as Pettis puts it: “A substantial amount of NPLs will one way or another increase government debt.”
Related links:
Treasuries, dollars and sense – FT Alphaville
Are Chinese banks massaging their losses? – FT Alphaville