Cloudy with a Chance of Torrential Credit

At 3 p.m. on January 18, the monetary policy department of China's central bank convened an emergency meeting of some commercial bank executives to discuss the lending situation in the first two weeks of the year.

The hour-and-a-half meeting was unusual. According to participants, some banks with excessive lending were ordered to halt lending that week.

Even more severe than the "stop order" were punitive, differentiated reserve ratio policies. While no list was announced, participants told Century Weekly that it would be hard for Bank of China, CITIC Bank and other excessive lenders to circumvent the order, which would add half a percentage point to their 16 percent deposit reserve ratio.

Previously, the China Banking Regulatory Commission (CBRC) had promoted dynamic capital regulation, tweaking capital adequacy ratio (CAR) levels. If banks could not comply with CAR requirements, they would face lending restrictions. Introducing differentiated reserve requirements, on the other hand, only takes into account whether banks are lending according to their own year-beginning plans. "This is like being squeezed by two hands at the same time. Space for issuing new credit is being compressed," an insider at a large Chinese bank told Century Weekly.

The reason for the regulatory heavy handedness is that by January 15, financial institutions had issued 110 billion yuan of new credit. If nothing were done, the Central Economic Work Meeting estimated that banks would easily exceed the government's target of 7.5 trillion yuan of new lending in 2010.

Sources close to the central bank say that the State Council's dissatisfaction with loan growth mainly stems from its large size, uneven pace and irrational structure. "The State Council is looking at credit numbers daily," the source said.

Many observers say that the central bank's supply-side measures are of limited use because the current credit growth is demand-driven. "Without raising interest rates, they will have no control over lending. But who is willing to rashly raise interest rates?" said a banking industry source. He estimates that the central bank will continue nudging the reserve ratio up in 2010. "But history shows that this will have a limited effect."

As of January 19, data obtained by Century Weekly showed that new loans in the banking sector had reached 1.45 trillion yuan. This means that despite orders from monetary regulatory authorities and at least two banks stopping loan approvals, the Chinese banking industry had issued over 300 billion yuan of new loans in only two days.

Radical Lending

In the first week of 2009, lending in China's banking industry hit a new record at 600 billion yuan of new credit.

On January 11, Monday of the second week of the year, the CBRC convened banking officials to persuade them to adopt a "balanced lending" approach.

The following day, the central bank unexpectedly announced that it would raise the deposit reserve ratio for major banking institutions by 0.5 percent to 16 percent.

But data through January 15 shows that the Chinese banking industry disregarded warnings and policy signals from monetary and regulatory authorities, issuing another 500 billion yuan in loans that week. "Some banks lent even more furiously than in the first week," a source close to the central bank said. "Some banks issued a half year's credit in two weeks."

A banking official at a large bank said that the fierce level of lending was stunning, "If it isn't controlled, lending this January will exceed the 1.62 trillion yuan lent in January last year."

Central bank data shows that as of January 15, 2010, Bank of China (BOC) led the industry with 167.2 billion yuan of new loans for the year. The Industrial and Commercial Bank of China (ICBC) followed with 164 billion yuan, and the Agricultural Bank of China (ABC) came in third with 107 billion yuan. The China Construction Bank (CCB) was relatively steady at 62 billion yuan, and the Bank of Communications came in last with 28.7 billion yuan.

Joint stock banks could not keep up with the big banks in large projects in the first half of 2009. When lending from large banks began to slow in the second half of the year, "They had just decided to make their move, but were told to stop. They were only given leftovers to eat," a regulatory authority source said. Joint-stock banks don't want to miss another opportunity. Among them, China Everbright Bank (CEB), which had refinanced only half a year before, was the most aggressive, with new lending exceeding 97.3 billion yuan. CITIC Bank followed with 80.2 billion yuan, while Huaxia Bank lent 51.7 billion yuan.

In terms of volume, ICBC, which was not a radical lender in 2009, has been the pacesetter in early 2010. An industry insider said that ICBC had been careless and had a late start. Generally, banks begin to control the scale and pace of lending mid-month. High-level executives at China's state-owned banks were rotated at the beginning of this year. Niu Ximing, ICBC vice president in charge of lending was transferred to president of the Bank of Communications.

BOC, on the other hand, had set a strategy of expanding its yuan loan business for early 2009 and thus made a market share push, leading the industry in new loans in 2009. Continued lending and refinancing considerations in the beginning of 2010 is an extension of this strategy.

Industry analysis shows that if new loans continue at this speed, new lending in the first quarter will reach 5 trillion yuan, exceeding the 4.58 trillion yuan lent in the same period of 2009.

Loan-limiting Orders

In desperation, the central bank convened the aforementioned credit situation analysis meeting on the third Monday in January.

On January 19, the second day of the meeting, multiple commercial bank executives confirmed that some banks had received "loan-limiting orders" from monetary authorities calling for the immediate halt to approvals and issuances of new loans. Banks that had maintained steady lending since last year were not subject to the limits. Additionally, the limits did not apply to loans that had already been approved, which could be issued as normal.

Industry sources say that BOC, with its massive lending, bore the brunt of the "loan-limiting order." A BOC Zhejiang Branch source confirmed that the branch had received orders from the head office to suspend all lending, including note financing. Additionally, Century Weekly received confirmation that ICBC, which was second only to BOC in lending in the first half of the month, had suspended its credit approval system.

Even more substantial is the decision to place a differentiated reserve ratio on the biggest lenders, even if their CAR and provisions are in line with regulatory requirements.

A source close to the central bank said that the central bank had long ago proposed differentiated deposit reserve ratios as a means of controlling credit issuance and had told banks that if their loan rate or scale exceeded the line, their ratios would automatically increase.

Banks slapped with punitive differentiated reserve ratios are possibly those leading lending in the first part of January, such as ICBC, BOC, CEB, CITIC and Huaxia. Informed sources say that the central bank may raise the deposit reserve ratio for one large bank and one joint-stock bank by half a percentage point from the current 16 percent base and watch for results over a period of three months.

Dreams of Balanced Lending 

Monetary authorities may continue using deposit reserve ratio tools. From 2007 to May 2008, in order to curb an overheating economy, authorities adjusted the required deposit reserve ratio up 14 times. But the frequent use of this tool shows its ineffectiveness.

As to the central bank implementing differentiated deposit reserve ratios, an industry insider said, "Raising the reserve ratio leads to minor changes in the amount of the money parking with the central bank and will not weaken the bank's ability to create money. A bank will be able to make loans as long as it has deposits." In addition to this, he believes that bank lending may continue its rapid growth.

"The most effective method is to rely on administrative means to control credit quotas," a commercial banking source proposed in a sardonic tone.

Delayed Risks

During the Central Economic Work Meeting, an intense dispute erupted between central and local levels and between decision-makers and commercial banks as to the scale of new loan growth for the year. In the end, the conference set new loan growth at 7.5 trillion yuan and stated that the flexibility and focus of control policies would be strengthened.

Asked about public concerns regarding a loss of control over full-year credit growth, an authoritative source said that monetary authorities had sufficient measures and capability to ensure control over new loan issuance and that the two departments would be taking a multi-pronged approach to ensure that the total would not exceed the quota. But the effectiveness of controls will be evaluated based on loan quality. The difficulty for regulators is to support economic development while controlling the expansion of credit risks.

One high-level regulator expressed worries about the hidden risks of massive lending, "Even if loans make it to the real economy, will they necessarily be collected? Will there really be enough cars on those new highways? Will there be enough passengers for all the new airports?"

The regulator admitted that a number of potential risks would gradually appear after the surge of credit in 2009 reaches its destination. Controls need to be implemented in advance, as exposure of problems would be delayed.

The Big Four banks all predict that they will become super-banks with assets of over 10 trillion yuan this year but insist that this scale will not be achieved through mergers and acquisitions but rather from organic expansion. China's reliance on credit for economic development has already reached unprecedented levels, and the risks should not be underestimated. The ratio of the M2 money supply to gross domestic product, a major indicator of the national economy's reliance on monetary policy and credit issuance, continues to move upward, and has reached the rarely seen level of 160 percent.

"This means China's use of credit to drive the economy has reached a maximum, and continuing the policy could be counterproductive. The excessive accumulation of credit risk will inevitably result in non-performing loans in the future," a senior official at a state-owned commercial bank said.

On January 26, the CBRC will convene the fourth-quarter economic situation analysis meeting, at which point regulators are expected to produce more detailed regulatory measures.