China struggles to boost lending as households deleverage; decline in deposits triggers arbitrage concerns
Efforts to keep interest rates low have failed to boost borrowing, while creating opportunities for arbitrage.
China struggles to boost lending as real economy deleverages
The Chinese economy continues to struggle with lacklustre demand for financing from the real economy, despite the best efforts of central policymakers to boost market confidence and provide accommodating conditions.
Leading economic observers say this want of demand is made particularly evident by the latest round of financial data released by the People's Bank of China (PBOC) – which points to widespread deleveraging by households and businesses.
Borrowing by China's real economy on the decline
Official data points to a broad-based decline in borrowing by actors in China's real economy since the start of the year.
Total financing obtained by enterprises and households stood at 12.09 trillion yuan for the period from January - April 2024, for a decline of 2.35 trillion yuan compared to the same period last year.
Wang Jian (王剑), chief financial sector analyst at Guoxin Securities, writes that the fall in financing obtained by real economic actors is mainly due to a contraction in lending by banks to the non-financial sector.
New lending by banks was approximately 9.45 trillion yuan, for a decline of 1.81 trillion yuan compared to the previous comparable period.
Wang believes that Chinese households and businesses are preoccupied with deleveraging, and doing their utmost to avoid any rise in their indebtedness.
"Since February, growth in household lending has markedly declined, while many households are making repayments in advance, which indicates that the willingness of households to increase their leverage is at a low," Wang writes.
"Enterprise loan growth has fallen, and the willingness of enterprises to finance using bonds is weak, reflecting lack of motivation amongst businesses to increase their leverage."
High savings rates amongst households also imply reluctance to consume or invest.
"Household savings are seeing high growth in general," Wang writes.
"From January to April, 55.5% of the funds obtained by the real economy were eventually held in the form of household deposits, remaining at a comparatively high level," Wang writes.
"This indicates that the willingness of households to invest and consume is still weak."
Policymakers still need to raise confidence
According to Wang, China has struggled to bolster borrowing by households and businesses since the peak of the Covid-pandemic, despite the implementation of accommodating policy measures.
This has weakened the effectiveness of monetary policy adjustments, and hampered efforts to restore economic growth.
"From 2022 to 2023 the real economy obtained a large volume of ample funds under conditions of policy support," Wang writes.
"However, because the confidence of the real economy has weakened, and the circulation of funds has declined, the effectiveness of monetary policy transmission has declined, and the recovery of the real economy has been slow."
Wang also attributes the decline in levels of borrowing to the introduction of measures to make China's financial sector more market-driven.
"This year, policy authorities have been even more inclined to marketise the pace and scope of loan provision, in order tobetter suit the actual financing demands of the real economy," he writes.
"As a consequence, growth in personal loans and medium and long-term financing by businesses has declined."
Contraction in deposits and rise in WMPs trigger arbitrage concerns
China has seen a sharp rise in allocations to wealth management products (WMPs), as savers seek stronger yields in response to falling deposit rates.
Some analysts have expressed concern that the market could also be seeing widespread arbitrage, as lending rates fall yet bond-backed financial products post strong returns.
Savers flee from deposits to WMPs
Data from the Chinese central bank indicates that renminbi deposits fell 3.92 trillion yuan in the month of April, with households posting a contraction of 1.85 trillion yuan and non-financial enterprises a fall of 1.87 trillion yuan.
Figures from PYStandard likely solve the mystery of the final destination of these fleeing funds.
Its data indicates that the total volume of outstanding WMPs stood at 28.42 trillion yuan as of the end of April, for an increase of 2.34 trillion yuan compared to the end of the previous month.
Deposits lose their appeal as interest rates tumble
China is currently pushing to reduce borrowing costs for households and businesses, in a bid to keep the real economy in fine fettle and revive the ailing property market.
In addition to a fall in lending rates, these efforts have also led to a decline in deposit rates, as banks seek to preserve their net interest margins in order to maintain profitability.
"Many small and medium-sized banks have recently announced reductions to the rates for their fixed-term deposits," said Li Xia (李霞), researcher with PYStandard.
The decline in deposit rates has gained impetus from a ban imposed by the Chinese financial system on the use of "manual interest supplementation" (手工补息) by banks to compete for funds from savers.
In April, the Market Interest Rate Pricing Self-disciplinary Mechanism (市场利率定价自律机制) – an industry disciplinary body comprised of Chinese financial institutions, sought to tamp down sector-wide deposit rates amidst a contraction in net interest margins that pose a threat to profitability.
It issued the elaborately titled "Initiative to Preserve the Competitive Order of the Deposit Market and Prohibit the Use of Manual Interest Supplementation and High Interest to Grab Funds" (关于禁止通过手工补息高息揽储 维护存款市场竞争秩序的倡议), banning banks from guaranteeing or paying any supplementary interest to customers beyond the authorised ceiling for deposit rate.
The Self-disciplinary Mechanism said the move was for the purpose of "stabilising the liabilities costs of banks," which are incurred by banks when they borrow funds from savers by providing them with interest-bearing deposits.
A report CIB Research found that the rates for bank deposits fell across the board in the wake of the ban on discretionary interest rate adjustments.
Interest rate declines boost appeal of WMPs
While efforts by Chinese authorities to keep interest rates low have tarnished the appeal of bank deposits, they’ve had the opposite effect on the attractiveness of WMPs.
This is because funds raised by financial institutions using WMPs in China are primarily invested in the bond market. Falling interest rates have the effect of boosting bond prices, which in turns raises yields on WMPs.
Lou Feipeng (娄飞鹏), a researcher from China Postal Savings Bank, said a key driver of the large-scale increase in WMPs in April was the strong performance of the Chinese bond market.
This increased the appeal of WMPs for investors, just as Chinese banks were reducing deposit rates to deal with narrowing interest margins.
"[Deposit rate reductions] may trigger changes in the asset allocations of investors, causing deposits to 'move house,'" said Li Xia.
Wen Bin (温彬), chief economist with China Minsheng Bank, expects the shift towards WMPs to continue through the remainder of the year.
He forecasts that outstanding WMPs could approach 28 trillion yuan by the end of the first half, and rise further to 30 trillion yuan by the end of the year.
Arbitrage concerns
Some analysts have expressed concern that companies in China are taking advantage of the disparity between lending rates and yields for bond-backed WMPs to engage in arbitrage, instead of using credit for real investment.
Analysts from Rhodium believe some corporations are re-routing credit obtained from depository lenders back into the banking system, in order to exploit the spread between loan rates and yields on other financial products.
"What corporations in China actually seem to be doing is taking cheap 2 - 3% bank loans and channelling the money back into banks' wealth management products, long-term time deposits or other investment products," Rhodium Group analysts wrote.
Other observers assert that regulators have already staged interventions to curb such forms of arbitrage.
"Regulation has effectively contained financial arbitrage, with the scale of enterprise financing falling considerably," writes Wang Jian (王剑), chief financial sector analyst at Guoxin Securities.