After posting record earnings in 2011, Chinese banks are facing a squeeze this year. Weak external demand hurts lending and weakens its asset quality. Deposits are harder to find, due to the decline in the automatic inflow from the shrinking trade surplus. Hit by poor external demand, losses are rising on loans to smaller businesses.
Funding hasn’t been a problem until very recently. During the last decade, China’s central bank has massively expanded its balance sheet – pushing money into the banking system. The goal of printing yuan is to capture the excess dollars created by the trade surplus so the yuan doesn’t rise too quickly. The People’s Bank of China was responsible for 52 percent of new broad money creation globally in 2011, according to Standard Chartered.
But the trade surplus has been shrinking as the yuan’s real exchange rate has risen, so the PBOC has not needed to create as much new money. From January to March, the quantity of yuan injected into the system in exchange for foreign currencies was three quarters lower than a year earlier. The result is a slower pace of money creation: annual M2 growth decelerated to 13 percent in March, down from 30 percent in late 2009.
As the growth of money supply slows, banks will have more trouble finding deposits, especially cheap ones. Already, banks are being forced to rely more on higher cost sources of funding: asset management products and interbank borrowing. More expensive funding has reduced interest rate margins and could start to constrain credit creation.
The margin narrowing comes at a bad time for the banks. They’re being hit by higher losses, especially from small and medium-size exporters. The main problem is relatively weak export demand. Non-performing loans at Shenzhen Development Bank surged 35 percent during the first three months. Mingsheng Bank, which also focuses on small companies, saw a 40 percent jump in “special mention” loans in the second half of 2011.
Beijing still has ways to push up lending, such as cutting reserve requirements or adjusting loan-to-deposit ratios. But as China’s export engine slows and bad debt rises, banks will find life more difficult.