Outgoing premier Wen Jiabao’s final economic report last week included a relatively stringent M2 money-supply growth target of 13 per cent – just below actual growth of 13.8 per cent in 2012. The real GDP growth target was basically unchanged at 7.5 per cent. This implies a neutral to slightly tighter monetary policy stance by the People’s Bank of China (PBOC).
However, traditional metrics such as M2 and bank loans are becoming a less accurate measure of China’s liquidity conditions since shadow banking- off-balance-sheet, or informal, lending – surged in 2009. The PBOC’s broader measure, known as ‘total social financing (TSF)’ is a better gauge of overall liquidity, as it captures a variety of informal funding channels including trust loans, entrusted loans, corporate bonds and equity financing in addition to traditional bank loans.
In 2012, the TSF stock/GDP ratio jumped to almost 200 per cent from a trough of about 140 per cent in 2008/2009. The PBOC has capped outstanding formal bank loans at about 130 per cent of GDP since 2009. But the informal lending/GDP ratio has surged to 65 per cent in 2012, a 15 percentage point jump over four years.
It’s too soon to say that this is a bubble. Still, it’s clear that traditional bank loans have become less important in funding economic activity, particularly in the past year. Corporate bond financing and trust loans have become very popular. After a surge in recent months, trust loans have surpassed insurance as China’s second largest financial sector by assets after banking. As a result, informal lending has surpassed formal loans in the TSF flow.
Trust funds have allowed companies to get faster financing, as Chinese banks have become more reluctant to lend to state firms, particularly property developers and local government entities. Banks have also sought to circumvent formal lending curbs by making off-balance-sheet loans.
There are some merits to informal lending. It provides a new funding channel for the private sector, particularly small- and medium-sized enterprises. Corporate bond issuance promotes the development of capital markets. And for borrowers, it’s between 100 and 130 basis points cheaper to tap the bond market than to take a bank loan.
So, what are the problems?
First, there is a duration mismatch for banks’ balance sheets because a new wave of wealth management products (WMPs) has been a major funding source for informal loans. WMPs now account for about 18 per cent of Chinese households’ bank deposits and have an average duration of just three to six months. For bonds that banks purchase and for informal lending, the duration is three to 10 years.
Second, a potential downturn in the property sector is a major vulnerability. While the exact composition of informal lending borrowers is sketchy, we know that developers and local governments have aggressively tapped the trust loan markets.
Third, the policy response may be another risk. Theoretically, the government can smooth the tightening process. More often, China tends to be blunt and abrupt when cracking down on imbalances.
The bottom line is that the more extreme the informal lending boom becomes, the greater the potential hangover. As China grapples with these challenges, we suspect the government’s overall policy stance may not be as pro-growth as previously thought.
Anthony Chan is Asian sovereign strategist – global economic research at AllianceBernstein.
