MNI EXCLUSIVE: PBOC Eyes Easy Policy Risks As Economy Recovers

The People's Bank of China is growing more concerned by the prospect of rising bad loans and a resurgence in shadow banking, but will hold off from any move to tighten policy while the economy continues to recover from the Covid-19 pandemic and could still introduce some additional targeted stimulus, policy advisors and sources told MNI.

The PBOC has since May moderated the easing bias with which it sought to revive output from lockdowns earlier in the year, and, according to Zhang Yongjun, deputy chief economist at the China Center for International Economic Exchanges, further cuts in interest rates or reserve requirement ratios would only come if the economy sags again over the next two months. The M2 measure of broad money is expanding at a relatively rapid 11.1%, indicating policy is still loose, he said.

The central bank may rely on open market operations to control liquidity and guide rates should the need arise, Zhang said. The loan prime rate - a benchmark for loans to companies - was kept on hold for a third straight month in July.

Policy makers are also becoming warier of the negative side effects of easy policy as the economy regains its footing, such as the danger of blowing bubbles in property and stock markets.

RISE IN NPLs

The China Banking and Insurance Regulatory Commission said on Thursday the government is making plans to deal with a significant increase in nonperforming loans, and indicated it would prevent any resurgence of high-risk shadow banking activities or excessive inflows into property.

While the central bank is also concerned about risks, the economy is still too fragile for a shift to a tightening bias, said Zhang and Chen Daofu, deputy director at the Financial Research Institute of the Development Research Center of the State Council. Q1 growth beat expectations, but it was boosted by better-than-forecast exports, particularly in June, Chen said, while Zhang noted that robust infrastructure and rising inventories came thanks to official credit support.

The main risk for the PBOC is further deterioration of bad loan ratios, particularly those of regional banks, after they were ordered to boost credit to support small businesses through the pandemic, said a source familiar with policy operations.

Although the total bad loan ratio is still low, it usually rises with a time lag in a downturn, the source said, noting that many small creditors are still benefitting from special pandemic deferrals of interest and principle payment until next June.

In March, the CBIRC approved the creation of China Galaxy Asset Management Co., to take on bad loans, a move which the source noted followed the model employed by authorities from 1999 to 2005 when four big national asset management companies dealt with CNY1.4 trillion in state-owned banks' NPLs. Monetary and fiscal authorities would work together to clean banks' balance sheets, the source said.

The bad loan ratio for small and micro companies was 3.22% at the end of 2019, according to the most recent CBIRC data. Loans to small and medium-sized companies and market entities grew 25.93% year-on-year by the end of March 2020 to CNY12.55 trillion.

SHADOW BANKS

Shadow banking, a major target of deleveraging campaigns in the past and typically involving wealth management products sold by banks, is also rebounding under easy monetary conditions.

Broadly-defined shadow banking assets increased by CNY100 billion in Q1, the first rise in two-and-a half years and following a decline of CNY2.3 trillion in 2019, according to Moody's. Broad shadow banking assets as a share of nominal GDP increased to 60.3% in Q1 from 59.5% at the end of 2019, the rating company said.

Trust lending to the infrastructure sector via local government financing vehicles also jumped, and smaller banks are seeing rising incentives to fund non-banking financial institutions, according to a Moody's report.

New varieties of wealth management product are appearing, said Xu Hongcai, deputy director of the Economic Policy Commission of the China Association of Policy Science, noting that while regulators began tightening supervision of the sector two years ago, significant areas of risk remain unaddressed including the high fixed returns offered by roughly half of WMPs.

While shadow banks provide an important source of funding for small companies and an alternative to investors who otherwise face negative real interest rates on bank deposits, regulation needs to be tight, he said.

Financial institutions' leverage ratio rose to 57.7% on the asset side in Q1, the first quarterly increase since March 2017, according to the National Institution for Finance and Development under the China Association of Social Science. China's total debt/GDP ratio jumped to 259.3% in Q1 from 245.4% at the end of 2019.