MNI: Global Banking Turmoil Drives Chinese Investor Caution

Global banking turmoil has rattled China’s investors. While the country’s banking system seems to have escaped unscathed, the wipeout of Credit Suisse’s hybrid bonds has forced investors – many lenders themselves – to review their domestic allocations to subordinated debt and enhance their liquidity management.

The unexpected wipeout of Credit Suisse’s USD17 billion Additional Tier 1 hybrid bonds has fueled caution among China’s investment community, which was already suffering from its U.S. Treasuries exposure following the U.S. Federal Reserve’s decision to start raising interest rates in 2022.

Pushed by regulators to recapitalise, Chinese lenders accelerated the issuance of subordinated debt after 2019, printing about CNY2.1 trillion of bonds that included write-off terms similar to those found in Credit Suisse’s hybrids, according to a fixed-income analyst. He warned domestic competitors hold 20-30% of perpetual bonds, which may increase risk during “black swan scenarios”.

Spreads on Chinese perpetual notes and Tier 2 bonds widened over March. Yields on state-owned bank issued two- to five-year perpetual notes rose about 10bp, while small-bank issued one-year T2s recorded a 60bp jump over the same period.

INVESTOR LOSSES

An advisor who spoke to MNI anonymously said western banking losses have not been fully realised, pointing to the USD18 trillion of negative interest-rate bonds outstanding in Europe.

Institutions holding these bonds, particularly insurance companies, already face large book losses, which have not yet been fully disclosed, he added. The advisor expects the Fed to hold interest rates at about 5% for some time, which will lead to further asset price corrections and increase risk. Investors remain risk adverse and this could also trigger a fresh round of liquidity issues, the advisor said.

The problems affecting small and medium-sized U.S. banks could deteriorate confidence in small Chinese lenders, some of which are already suffering from undercapitalisation, low asset quality and high funding cost. They also have invested heavily in debt raised by local Chinese government funding vehicles, which have been under pressure recently.

Chinese policy advisors and economists say China’s institutional investors have suffered from a sharp fall in the value of US Treasury and mortgage securitisations. According to the U.S. Treasury, Chinese investors' U.S. Treasuries exposure dropped USD173.2 billion over 2022 to USD867 billion.

The advisor said Chinese investors sold USD12.6 billion of U.S Treasuries last year, which means they were down about USD160.6 billion due to declines caused by rising long-term US interest rates and the subsequent market sell-off.

CHINA STRENGTH

China’s small- and mid-sized lenders should diversify their loan book and asset portfolios and scrutinise interbank operations to limit risk, despite limited impact from the west’s banking turmoil, according to Chinese banking officials and advisors. China’s banks largely benefit from the country’s prudent policy stance, a robust economic recovery and state control of the capital account, officials said.

The country’s banks, however, should take note of the international situation, conduct stress tests and react swiftly to avoid liquidity risk, according to Zhao Zhihong, vice president and chief risk officer at China Bohai Bank, a Tianjin-based regional lender. Lenders must strengthen internal communication with their domestic competitors to prevent situations that could lead to market panic, Zhao added.

Industry participants agree the collapse of U.S. regional banks and sale of Credit Swiss to UBS has limited impact on China’s banking sector. The county’s banks are largely immune to the turmoil engulfing the western banking system, according to Ma Jun, former chief economist at the People’s Bank of China.

China’s unique economic system, including the inconvertibility of its capital account and its position in the interest-rate cycle offers shelter from the turmoil, and helps protect the country against transmission of external shocks, Ma added.

He explained interest-rate hikes in 2022 triggered the U.S. and European banking woes, however, the PBOC lowered rates in 2022. In addition, the country’s economic recovery in 2023 will improve asset quality and cushion banks from the global volatility, compared to the recessionary risks major western economies are facing, he added.