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FINANCE

Bank-to-Bank Lending, ‘Growing Unchecked,’ Stifles Attempts to Boost Economy, Experts Say

By Wang Yuqian

(Beijing) — An increasing amount of money in China has been trapped inside the financial industry, flowing from one bank to another, increasing the risk of bubbles and thwarting the government’s efforts to stimulate the economy, analysts said.

The part of money being created by banks, which is not included in the calculation of M2 — the most oft-cited money supply indicator — has been “growing unchecked,” according to a research report by Haitong Securities. The growth was fueled to a large extent by banks’ lending to each other aggressively and investing in each other’s wealth management products, the report said.

China’s M2, which includes cash, individual and corporate deposits, grew by 12.2%, 13.3% and 11.3% in 2014, 2015 and 2016 respectively, down from a temporary peak of 27.6% in 2009, when a massive stimulus plan boosted the supply of credit.

Using these growth rates to calculate the overall amount of credit that has actually been created over the past few years, however, will lead to an underestimate because “M2 doesn’t capture the money created by banks’ lending to each other and to non-bank financial institutions,” analysts Jiang Chao and Liang Zhonghua wrote in the report. The authors didn’t estimate the real growth rate of China’s money supply.

Negotiable certificates of deposit (CDs), for example, have become a key source of funding for national joint-stock banks and city commercial banks, which combined make up nearly 90% of the 7.4 trillion yuan ($1.1 trillion) worth of outstanding CDs as of March, according to the report.

The market of CDs has exploded since opening in late 2013, largely because they allow banks to circumvent restrictions on interbank borrowing. Funds received from another financial institution in the form of CDs are exempt from the central bank’s reserve requirement and are treated differently from other types of interbank loans, which cannot exceed one-third of a bank’s total debt.

Along with the surge in the issuance of CDs, more than 15% of bank wealth management products were held by other banks as of June 2016, up from less than 4% at the beginning of 2015, an increase of 3.5 trillion yuan over a period of just 18 months, according to the report.

However, a lot of the investment has been circulating within the financial industry, fueling speculation and bubbles rather than being made as loans to support nonfinancial enterprises.

“No one in the banks knows where the money they invested in other banks’ wealth management plans ended up,” an official from the central bank told Caixin earlier. “They could not tell because the selling bank itself used the funds to buy other banks’ wealth management plans.”

Taken together, banks’ leverage ratios have surged as they borrowed more and more from each other.

A simplified way to measure the leverage, as provided by the report, shows that, on average, the total assets of depository financial institutions in China (excluding the central bank) have grown to almost 50 times their net capital. The ratio for some midsize banks, which rely more on interbank loans, has reached 60. In 2007, the average ratio was just about 30.

The high assets-to-net capital ratios are alarming compared with those in the United States, which has not exceeded 20 since 1970s, or those in Japan and South Korea, which have remained below 30 most of the time, the report said.

Recent measures taken by the central bank suggest the regulator has taken the risk seriously and will rein in interbank lending and investment.

It is already applying more scrutiny to most interbank dealings with the Macro Prudential Assessment (MPA) framework, a comprehensive financial risk monitoring and mitigation system implemented last year.

A crucial element of the system, called “general loans,” covers not only conventional bank loans to companies and individuals but also bond purchases, off-balance-sheet investments, and various loans to other financial institutions. Three city commercial banks have been punished recently for failing to meet the standards.

Interbank lending through CDs was still climbing, reaching a record net increase of more than 900 billion yuan in February. But it may slow down in March as the quarterly MPA review approaches, according to the report.

Contact reporter Wang Yuqian (yuqianwang@caixin.com)

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