Opinion: Credit Checked

Since the fourth quarter of last year, the pace of credit expansion has slowed significantly, and the growth rate of total social financing (a broad measure of credit and liquidity in the economy) has dropped from about 13% to 10.5% within five months. I believe that this is not a short-term phenomenon. Even if the slowdown moderates, total social financing’s annual growth rate is unlikely to return to the 12-13% range.

I consider capital to be the basic constraint on on-balance sheet credit expansion. At present, the overall capital adequacy ratio of banks is still higher than the level regulations require; and even if this year banks rely on loan growth to maintain total social financing growth, this will still not cause the overall adequacy ratio to immediately fall below the red line (though it might for some banks). But if we look at the broader trend, the growth rate of banks’ capital, especially tier-1 capital, has been declining since 2015, from over 21% to around 10% — falling from far above the growth rate of risk-weighted assets, to close to or even slightly below it.

More pressure on nonstandard loans will cause banks’ profit growth to slow further and reduce the endogenous growth rate of capital, and bringing off-balance loans back onto balance sheets will increase the growth of banks’ risky assets. These trends will put pressure on banks’ capital adequacy ratios from both sides. This means that unless banks carry out sufficient refinancing, the constraint of capital on credit will continue.

In addition, risk aversion caused by the recent increase in bond defaults is also dragging on credit expansion. Since the beginning of this year, eight issuers have defaulted on their bonds, with the amount involved greater than that of the same period last year. Unlike the surge in bond defaults in 2016, this round of defaulting companies have mainly run into problems due to liquidity, not continuous losses, and they are not concentrated in the manufacturing industry. Although companies that default due to liquidity crises are relatively easier to rescue, the crises themselves are often harder to identify in advance, so investors can only reduce their overall risk appetite. Since May, the net increase in debentures has turned negative, reflecting how defaults have had a significant impact on corporate bond financing; and this may also spread to other market-based financing.

For these reasons, I believe that strategies the government has used in the past to alleviate credit contraction will not be effective in the current environment. First, with regard to financing channels, because nonstandard debt, bond issuances and other financing methods already account for 40-50% of overall financing, even if banks move to relax their loan limits, this will only have a very limited effect; and the loans will also be subject to capital constraints.

Second, with regard to financing entities, declines in private sector financing in the past have often been ameliorated by the government adding leverage. For example, during the surge in bond defaults in 2016, local government debts were used to offset the credit contraction of some enterprises. But local government financing is also subject to strict limitations at present.

Third, because liquidity is not the main bottleneck for credit expansion, monetary policy also won’t be of much help. For example, the new regulations on asset management mean that even if monetary policy is loosened, off-balance sheet nonstandard financing will continue to shrink. The People’s Bank of China recently expanded the scope of the collateral it would accept for its medium-term loan facility (MLF), intending to increase market confidence in medium and low-grade bonds. But banks that can obtain MLF funding are not the main investors in medium- and low-grade bonds, so the effect may fall far short of the central banks expectations.

From a longer-term perspective, if the macro leverage ratio (the ratio of total social financing to nominal GDP) is to be kept stable, considering that the actual growth rate of gross domestic product (GDP) can only be maintained at 6-7%, plus 2-3% of inflation every year, the growth rate of nominal GDP cannot be maintained at more than 10%; so the growth rate of total social financing must also be kept within 10% in order to match the growth rate of nominal GDP. This year marks a change of gear for the growth rate of total social financing.

Xu Xiaoqing is macro strategy head at DH Fund Management Co. Ltd.

Translated by Ke Baili (

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