Chinese New Year Credit Fireworks…

The fireworks display was underwhelming this week in Beijing to reflect the new mood of official frugality, but China’s spectacular credit growth in January was more jaw dropping than any pyrotechnics. New RMB lending surged to 1.07trn RMB ($172 billion) in January, the highest since January 2010 amid the last cyclical credit boom, when loans hit 1.39trn RMB, while M2 money supply growth accelerated to 15.9% y/y. Aggregate financing in the month exploded to 2.54trn RMB ($410bn). Overall, 60% of total credit creation originated from the shadow sector of trusts, corporate bonds, loans by investment companies, direct intercompany lending and banker’s acceptances and the 40% share of core banks was up from its lowest ever level in December, but well below the 52% of annual 2012 aggregate financing. Overall, the recent credit injection (even allowing for fast deteriorating incremental credit efficiency, with each new RMB of output now requiring about 6 RMB of credit) suggests that the Chinese economy is likely to accelerate in Q1 to 8.5% plus growth, but systemic risks are once again building.

It’s getting increasingly hard for the central authorities to clamp down on ever mutating off balance sheet credit conduits, and brokerages are the latest one to emerge. When the government tried to clamp down on investment companies known as trusts, securities brokerages stepped into the off-balance sheet breach. They have been allowed to invest their own money and assets managed for clients in a much wider range of financial products, including bank wealth management schemes, since the securities regulator started implementing a series of new policies from October 2012. Banks favour securities firms over trusts because loans made through their asset management schemes do not count towards bank lending quotas. Trust companies have a fiduciary duty to investors (though their role has been limited to being only a capital conduit in the bank schemes); securities firms don’t even have this minimal responsibility, and hence charge much lower fees to the banks, a further incentive for banks to redirect flows their way.

The amount of assets managed by Chinese brokerage firms exceeded 1.2trn RMB at end 2012 from 280bn at the beginning of the year. Up to 90% of that total was tied to banks; in a typical structure, the bank entrusts the securities firm with funds raised from wealth management products, and the securities firm uses the money to buy the bank’s notes or invest in other types of financial instruments. The arrangement allows the bank to shift assets off its balance sheet and circumvent lending restrictions. The securities firm, in return, charges the bank a fee for using its service. The schemes mirror arrangements that allow banks to channel money through trust products to borrowers otherwise ineligible for bank loans. 

That tactic is used much less frequently because the CBRC since August 2010 has required all trust companies to cap the value of trusts tied to bank loans at 30% of their total outstanding products, while banks were required to include loans made through trusts on their balance sheet. It looks like similar measures may have to be implemented regarding brokerage products. Overall, the investment surge since mid-2012 is being enthusiastically funded, underpinning near term growth momentum. However, this is likely the last throw of the fixed investment policy dice. After a five year 60 plus percentage point surge in the outstanding credit/GDP ratio, China’s capital balance is approaching a similar and globally disruptive inflection point to that seen in coal or soybeans in recent years. The country looks set to become a sustained net importer of capital by late decade as domestic corporate and household savings peak, amid widespread post credit bubble asset deleveraging and balance sheet recapitalization. Enjoy the party while it lasts…