108.06台灣銀行家雜誌第114期 / By David Stinson
Who Will Fill the Gap for Private Chinese Borrowers?Bankers Digest
Capital, when put to economically productive uses, involves an inherent degree of risk. The contradiction between de-risking and economic growth is coming to the forefront as China’s deleveraging campaign enters its second year. These competing priorities have come to a head most pointedly in the private sector, where business executives have complained that state banks are being less helpful than before. In fact, the campaign is better understood as advocating qualitative, rather than quantitative changes in credit. The less efficient state sector has not seen major restrictions, but the shadow financing sector – upon which private industry relies heavily – has contracted significantly and will continue to do so in 2019. The Chinese government under President Xi Jinping has mixed views of private industry, but it apparently did not intend to use the campaign to alter the balance of the sectors so drastically. Its 2019 Government Work Report, released after the “Two Sessions” in March, noted that “the difficulties that private firms and small and micro businesses face in accessing affordable financing have not yet been effectively solved,” and promised measures to improve the situation.According to data from the investment management firm VanEck, the spread between borrowing costs for state-owned enterprises (SOEs) and privately-owned enterprises (POEs) increased from about 100 basis points at the beginning of 2018, to 225 basis points at the beginning of 2019. The difficulties faced by the private sector are multifaceted, including taxation policy, legal protections (such as for their business relations with SOEs), and also external challenges from the trade war. For many companies, who had been subsisting on underground lending channels (such as trust and entrust loans), financing has become an existential issue. Not only has the quantity of shadow financing decreased sharply, but also the loans themselves have become more short-term, forcing business owners to pay constant attention to market developments. Bridge financing is a perennial concern. It is also worth noting that these problems have coincided with a dismal stock market performance. The CSI 300 lost 25% of its value over 2018, making it the worst-performing index in the world, and also making 2018 the worst year in over a decade. The number of A-share IPOs decreased 40% from 2017; moreover, the ones that did occur were biased towards larger corporations, as the average deal size more than doubled. IPOs can form an exit strategy for financing at earlier stages, so these trends have larger knock-on effects.With this policy turnaround, the administration has recognized that the private sector was being pushed to the breaking point. The Work Report asked large state-owned commercial banks to increase their loans to small and micro-sized enterprises by 30%. This quantitative target highlights the organizational mismatch between China’s gargantuan government-backed winners and their much smaller lending targets. (Other countries resolve this problem through government-backed guarantees, for instance, rather than explicit targets.) At worst, this could mark a reversal of the earlier emphasis on risk control. Christopher Balding, former associate professor of business and economics at the HSBC Business School in Shenzhen, reports that banks have been aggressively pursuing smaller companies to take our no-collateral, no-questions-asked loans – quite a turnaround from just months ago. Besides the question of short-term financial stability, the situation also poses questions about China’s intended role for the state sector, as well as the future of shadow banking – which has borne the brunt of the deleveraging pressure. The problem is that shadow financing serves a useful social purpose, which must be either recognized or replaced somehow. Although the campaign will ease up in 2019 compared to 2018, this relatively new situation of capital scarcity has exposed gaps in the financial system. Some sort of solution is required that doesn’t involve periodic policy-based oscillation between extremes.The Bigger, the BetterThe Chinese model of regulation is based on the notion of equity ownership (i.e. supervision), rather than the ideal of a neutral, independent referee. In other words, a preference for scale is built into the system. Smaller, independently owned businesses do not play a particularly important role in Communist ideology. The government does not see the large policy banks as the only solution, but its primary consideration as it thinks about the subsequent development of alternative financing channels is control. In particular, it would prefer that either the borrower or lender be tied to the state, and large and centralized enough to implement policy goals.“Shadow financing” can refer to any unregulated or unofficial financing method. Discussions of shadow financing in China over the past five years have typically focused on wealth management products (WMPs) – investments often sold by banks or using their name, while remaining off the banks’ balance sheets. Looking forward, though, the shadow financing discussion will increasingly involve fintech lending. China has long been a leader in this sort of experimentation, partly due to the backwardness of its traditional financial system, a relic of a different era. It is important, however, to distinguish between the different functions of fintech: technology is only a means to an end. Specifically, the government is suspicious of all sorts of peer-to-peer technologies. P2P lending platforms have been generating spectacular headlines about massive collapses, leaving stakeholders in the lurch. Separately, as the government cracks down on outflows of proceeds from corruption, it has also frowned upon blockchain solutions allowing for P2P payments. Both of these technologies represent a loss of government control, and will probably not be brought back in the near future.At the same time, the central government is making it easier for individuals and SMEs to invest in local government debt. Starting in March, local government bonds became available over-the-counter on a pilot basis in Zhejiang, Sichuan Sha’anxi, Shandong, and Beijing. Although this measure will not have an appreciable macro-economic impact, it shows that the government is willing to allow disintermediation for individual savers when the targets are governmental. Thus, the policy environment is not necessarily against individual savers making their own investment decisions, but the P2P platforms are evidently not sufficiently active as intermediaries to meet Beijing’s objectives.Unique Chinese Solutions to Unique Chinese ProblemsSmaller businesses are a riskier lending target in any country. They are more likely to be run informally, and for household businesses it can be difficult to disentangle business from personal expenses. The private sector is generally more productive than the state sector, but this partly reflects the level of risk associated with the assets. Many private sector lending targets would be exposed to a slowdown in consumer demand.It is logical that smaller borrowers would be matched with smaller lenders. In an effort to avoid “flood-like” stimulus this time around, the government is also pushing for smaller regional and rural banks to increase their lending. In May, in the hopes of stimulating lending to SMEs, it cut their reserve requirement ratio to match that of the smaller rural credit cooperatives. These smaller banks were however more deeply involved in earlier WMP sales, and the government is now encouraging them to move such products onto their balance sheets. They also rely more on markets, rather than deposits to fund their lending, making the capitalization process more complex. Although these banks could form a healthy compromise between the large banks and technology-based platforms, they are still in the process of returning to health. Thus, these regional banks are not up to the task of rescuing the private sector, even as the bloated state sector continues to suck away capital for asset-intensive projects and zombie companies. It is unclear whether fintech platforms will be able to fill the gap in private sector lending, as their lightweight underwriting model seems more suited for micro-sized borrowers, and will probably encounter scaling problems at a certain point. (An exception however is for enterprises selling directly on the platforms themselves, where the amount of data generated can make up for the lack of formal banking processes.) Ant Financial raised a record-breaking US$ 14 billion in the first half of 2018, but its lending cannot yet be compared with China’s total social financing, in the hundreds of trillions of dollars.The success of lending platforms would however mark a major milestone for China’s economic and political model, allowing the government to upgrade its control over individuals into effective control over financing – and not just for the state sector. China’s success in transforming shadow lending also has relevance to the developing “Cold War” between China and the US. The results will not be seen within the time frame of any particular trade negotiation, but frictions between the full capitalism of the US and China’s social credit model will continue regardless. China does not accept pressure from the outside to reform. Its original dependence on shadow financing was unique for a large economy. For the sector’s reform as well, it will chart its own, idiosyncratic path forward. If China is successful, it may be able to export its model. The weakness of its legacy banks could potentially turn into a strength for the country as a whole. In the shorter term, though, the big banks are here to stay.