China’s Banks Tighten Credit

Inflation and tight credit are proving to be the two big economic issues in China this year.

On February 9, the People’s Bank of China, China’s central bank, raised the one-year borrowing rate by 25 basis points to 6.06 percent, and the rate on one-year deposits by 25 basis points to 3.0 percent. These rate hikes came amid increasing pressure on the Chinese government to control inflation. The February 9 increase was the first rise in China’s one-year benchmark interest rates this year, and signals a renewed effort to cool prices and tighten liquidity.

According to Andy Rothman, the China Macro Strategist for CLSA Asia-Pacific Markets, China’s efforts to reign in loan growth to slow inflation is already well underway. The growth rate of outstanding loans was 19.9 percent in 2010, far slower than 2009’s 31.7 percent pace. In 2011, Andy expects outstanding loans to grow at an even slower rate of 14.6 to 15.7 percent, in line with the average annual growth of 15.7 percent during the five pre-stimulus years, when China’s Consumer Price Index (CPI) averaged 3.6 percent.

In January, China’s CPI rose 4.9 percent. As we have reported previously on MTD, Andy believes that much of these recent price increases are food related and due primarily to weather conditions. Nonetheless, Beijing is responding with tough anti-inflation rhetoric and normalization of credit and liquidity flows back to pre-stimulus levels. Andy expects one more interest rate hike before CPI cools to a full-year average of 4.5 percent. If Andy is right, MTD’s prediction that CPI will remain below 3.5 percent may be in trouble, but it would still be good news for those concerned about inflation.

Apart from higher interest rates, anecdotal evidence that Chinese banks are tightening credit is growing. A bank officer at one of China’s big four state-owned banks said that new loans being offered are only 20 percent of loan demand. MTD has also heard from reliable sources that property developers are being asked to pay as much as 25 percent for new credit. The government is admittedly targeting property speculation, so this may not be as relevant to borrowers in other sectors. However, both the empirical and anecdotal evidence clearly suggests that 2011 will be a particularly difficult year for all companies to access bank credit in China.

Unlike the large state-owned companies, small and medium-sized enterprises, private companies and foreign-invested enterprises find it difficult to navigate China’s banking market, even in times of easy credit. For starters, China’s bank market is considerably more concentrated than that in other countries like the United States. For example, KPMG now tracks statistics for 153 banks in China, which is up from 21 in 2006, but a far cry from the 7,622 banks that operate in the United States.

Moreover, China’s largest banks are central government-controlled entities that tend to be somewhat bureaucratic or dedicated to making specific types of loans. As of the end of 2009, “The Big Four” state-owned banks — the Bank of China, China Construction Bank, the Agricultural Bank of China, and the Industrial and Commercial Bank of China — had assets of RMB 39 trillion ($5.9 trillion), almost double the amount of assets controlled by the next 11 largest banks in the country.

In addition to the Big Four, China has created three new “policy” banks— the Agricultural Development Bank of China that specializes in agricultural projects in rural areas, the China Development Bank that specializes in infrastructure financing, and the Export-Import Bank of China that specializes in trade financing. The three policy banks control another RMB 7 trillion ($1.1 trillion) of assets, bringing the total bank assets controlled by the Big Four and the three policy banks to RMB 46 trillion ($7 trillion), almost three times the amount of assets controlled by the next eight largest banks.

The balance of China’s 153 banks include second tier banks such as Bank of Communications, China CITIC Bank, China Everbright and Minsheng, as well as the city commercial banks, many of which were founded as urban credit cooperatives.

Banks in China prefer loans that are secured by land, buildings and equipment, and are most comfortable lending to state-owned enterprises where there is an implicit government guaranty. Typically, loans are structured with a one-year maturity, with the expectation that the loan will be renewed at the end of the year. This works well if business is good, but in my experience, companies will be pressured by the banks to find substitute lenders if the company encounters operational or financial problems in the interim.

Banks may offer longer terms if a strong corporate guaranty is in place, and/or if the local government applies pressure on them to provide favorable loan terms at the onset of a project. Generally, only the strongest medium sized enterprises with a long operating history can access bank loans in China. In most cases, these loans are extended locally, rely heavily on relationships, and are due at the end of one year.

All in all, 2011 will be a difficult year for companies that may need to access bank financing in China. This may be good news for inflation watchers, but it will be a big headache for those charged with funding their company’s China operations.

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