China City Commercial Banks Struggle Amid Deleveraging Process

     BEIJING (MNI) - City commercial banks in China are struggling to survive

the rising costs of wholesale funding and a reduction in deposits from business

customers, resulting from the government's continued deleveraging campaign and

tightened financial regulations.

     According to the China Banking Regulatory Commission, growth in both assets

and liabilities of city commercial banks slowed to 18.5% year-on-year in July,

compared with growth of 24.2% in July of last year and 24% for the whole of

2016, although July's figure was higher than the 18% growth in both assets and

liabilities in June. It was the second-lowest rise since March 2015, when assets

and liabilities rose 18.3% and 17.9%, respectively. 

     Most city commercial banks in China were transformed from city cooperatives

during the mid-1990s. Their main task is to provide financial services to small

and medium-size enterprises within their home cities to support local economic

development. Their size and financial profiles can vary significantly, with

their performance and deposit franchises highly correlated to the local economy.

     "Our asset growth shrank to below 7% year-on-year in the first half this

year from over 46% during the same period last year, indicating that rapid

expansion, which was reliant on leveraging, has ended," Shu Xingnong, the head

of Nanjing Bank, said last week at the China Banking Development Forum in

Beijing. "Deposits, assets and profits will all be badly influenced, as

wholesale funding has been curbed by regulators," he noted. 

     According to its 2017 half-year report, Nanjing Bank's total assets rose

just 6.48% in the first half of the year to CNY1.13 trillion, compared with

32.16% growth in 2016.

     Grace Wu, head of China banks ratings for Fitch Ratings, told MNI in an

interview that "there is a more evident trend of deleveraging at the smaller

banks, as higher funding costs and tighter regulations have restricted their

shadow banking activities."

     "We believe the margin pressure at smaller banks is due to the increase in

wholesale funding costs during the first half, as these banks have weaker

deposit franchises and are more reliant on wholesale funding relative to the

state banks," she said.

     "Fitch expects the deceleration in asset growth, together with margin and

asset quality pressures, to linger in the near term for the smaller banks," she

noted.

     Interbank transactions, the main channel for obtaining wholesale funding,

saw a sharp slowdown in the first half of the year, shrinking for the first time

since 2016, Xiao Yuanqi, head of the prudential regulation bureau of the China

Banking Regulatory Commission, said at a press conference last week. As of the

end of the second quarter, total interbank assets in China dropped 5.6% to

CNY1.8 trillion, and interbank liabilities also dropped to CNY1.8 trillion.

     The change can especially be seen among city commercial banks listed on the

Chinese A-share market. WuXi Bank in Jiangsu province saw 1% growth of total

assets in the first half, down from an 8.36% increase in 2016, while its

interbank transactions fell 73.4% year-on-year to CNY1.4 billion.

     The cost of wholesale funding has surged this year, restraining the

expansion of city commercial banks. The yield on negotiable certificates of

deposits (NCDs), a major way  banks conduct wholesale funding, has jumped

significantly. As of Aug. 25, The yield on three-month NCDs with "AAA" ratings

jumped 181.16 basis points to 4.5%, compared with 2.6884% on the same day last

year.

     "The previous explosive expansion of city commercial banks was due to

'non-risky arbitrage' in the interbank market, resulting from excess liquidity

under the loose monetary policy and regulatory loopholes," Zhang Ming, chief

analyst of the banking sector for Huachuang Securities, told MNI. "But it is

unsustainable, as regulations are not going to be loosened in the near term."

     What is more, the reduction in company deposits, usually the pillar of city

commercial banks' assets, could severely impact their growth prospects,

especially in light of the fact that their interbank businesses have come under

tighter control and they cannot compete with the country's larger banks in

attracting individual deposits.

     "The credit controls during the process of deleveraging have made the

situation even worse, as total social financing and M2 continue to drop," Zhang

said.

     China's total social financing decreased by CNY1.22 trillion in July,

compared with an increase of CNY1.7762 trillion in June, while M2 money supply

growth in July hit another historic low of 9.2% year-on-year.

     However, in the eyes of some city commercial bank heads, the deleveraging

campaign and tighter regulations have had a silver lining, forcing the banks to

find alternative ways to raise funds.

     "The structural changes required under deleveraging along with [tighter]

regulations have indeed caused a significant impact, and we have to diversify

channels for raising funds and manage liquidity cautiously," Chen Mingxiao,

chairman of Jiangxi Bank, said at the forum. "But it is necessary, or we could

lose the high profits we enjoyed in previous years overnight if the bubbles in

interbank transactions burst someday."

--MNI Beijing Bureau; +86 (10) 8532 5998; email: marissa.wang@marketnews.com

--MNI Beijing Bureau; +86 (10) 8532-5998; email: vince.morkri@marketnews.com

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