Andrew Collier, Managing Director, Orient Capital Research spoke with Doug Krizner and Juliette Saly on the on PBOC’s official newspaper saying China should expand the yuan’s trading band. He sees a lot of downward pressure on the yuan. He also looked at the flurry of M&A activity seen early this week.
Running time 06:37
https://www.bloomberg.com/news/audio/2017-07-12/pboc-good-at-saying-one-thing-and-doing-another
http://www.npr.org/sections/parallels/2017/06/30/534967496/how-hong-kongs-banks-turned-chinese
And that means a sea change is underway for the job prospects of young Hong Kongers. “It used to be that you got out of college in Hong Kong, you were an invaluable resource because you had some sort of Mandarin skills, you spoke English and you were trained in finance, and you had no competition,” says Andrew Collier, managing director of Orient Capital, and author of Shadow Banking and the Rise of Capitalism in China.
In the past decade, shadow banking has taught China great lessons about capitalism. That is, except for the most important one: failure.
Since the 2007 financial crisis, China has poured more than $600bn into the economy to avoid getting caught in the downturn. Alongside the formal bank loans have been a flood of money from the informal or “shadow” economy. These loans have been funnelled through a variety of financial institutions, including government-owned trusts, investment banks, Mom and Pop shops and even the state banks. Shadow finance amounts to approximately 80 per cent of China’s GDP, up from less than 10 per cent a decade ago.
One corner of this shadow market has been an important teacher of capitalism to the ordinary consumer: wealth management products (WMPs). These financial instruments have ballooned into a $4tn market and include everything from investments in commercial property to a small business or a corporate bond.
With the growth of WMPs, Chinese citizens have been able to avoid the casino-like stock market, and the paltry returns from savings deposits in the banks, and put their money into new projects.
Like touts at a carnival, the banks selling them have promised outsized returns — 10, 12, 15 and even 20 per cent, for all sorts of investments. WMPs have caught the imagination of a rising middle class and wealthy elites hungry to benefit from their newfound wealth.
But this wild west of investments has come with a starry-eyed optimism about China’s economic growth. No project is deemed worthless.
I met one saleswoman for an investment bank who kept asking me what kind of investment return I wanted. I repeatedly asked, what is the project? Her response? “I think it’s a bridge in Nanjing.”
In fact, there is widespread suspicion even among Chinese that many of these loans are Ponzi schemes, under which new money simply replaces an earlier loan.
The enthusiasm for WMPs is based on two axioms. First, China’s economic growth will go on forever; and second, the Chinese government is behind all these investments. Neither may be true. In case of a downturn, who is backing these orphan investments?
At root, capitalism is about the efficient allocation of capital towards profitable ends. And with that comes success and failure. China’s booming economy and reluctance by the banks to allow a default has prevented consumers from experiencing losses. That could change.
Technically, the banks are not responsible for these products. Most of them are “off-balance sheet”, so banks do not have to account for them as part of their loan book. Once the contract has been signed, they have been paid their sales commission and the buyer is out the door, the banks wash their hands of these loans.
While the People’s Bank of China, the central bank, has made halfhearted attempts to slow the deluge of WMPs, the leadership approves of this growing pile of personal debt. “The household is under-leveraged,” a senior regulator in Beijing told us recently. Beijing is happy to shift debt from the state and corporates to the household because it views this as removing a problem from the official economy.
However, this game is going to become increasingly difficult if there is an event, such as a big fall in property values, that triggers a crisis in confidence in China’s WMP market. If buyers flee, what will China’s central bank do if $4tn in loans suddenly vanish? Is it able or willing to fill bank coffers with new money? And what would China’s connected ambitious middle class do if their wealth vanished overnight? What would widespread default mean for faith in the Chinese leadership?
Any problems would rifle through China’s economy like dry timber in a forest fire. Corporations, banks, even local governments could face financial ruin if this huge pile of credit is withdrawn. Many local governments rely on household financing through WMPs for pet projects that have helped to bolster the property market and drive up land sales, a key source of revenue for them. And some of the smaller regional banks have started to use WMPs to increase their asset base.
A collapse of the WMP market could jolt China into a financial crisis.
Already, the warning bells are ringing. In May, China’s Foresea Insurance warned of “mass defaults and social unrest” if Beijing forced the market to cancel issuance of WMPs.
China needs to reduce its reliance on easy credit, increasingly placed on the backs of households, and allocate whatever capital is available to more productive uses. This would require a more efficient banking system and less credit to state companies.
Shadow lending has taught consumers an important lesson about investing in a capitalist world. Let’s hope that Beijing has enough sense to teach the harsher lesson about capitalist failure without causing a financial crisis.
Andrew Collier is managing director of Orient Capital Research and author of a new book, “Shadow Banking and the Rise of Capitalism in China”.
http://www.chinafile.com/library/books/shadow-banking-and-rise-of-capitalism-china
Bad Economic Benchmarks in China
Why Shadow Flows are a Better Indication of the Economy’s Strength than Official Data
Summary
A fund manager recently told me he relies on three sets of data to monitor the strength of the Chinese economy:
However, I would disagree with the use of these three benchmarks because they have significant flaws. Instead, I believe that shadow banking credit flows – particularly the highly liquid and volatile Wealth Management Products – are the best benchmarks.
Interbank Rates as ‘Signaling’ Device
Interbank rates, to begin with, traditionally have not been a prime indicator of stresses in the system. The interbank rate is essentially a “signaling” device by the PBOC to the financial system. Most recently, in the past year or so, it has been aimed primarily at the weaker institutions, including smaller banks, and banks reliant on short-term funding (eg, WMPs). It is true that smaller banks have relied on interbank loans for up to 30% of their funding. But the interest rate is fairly well controlled by the PBOC.
Thus, the interbank rate is not really an “indicator” of monitory conditions. As the WSJ wrote a few months ago: “The rising rates have made it much more expensive for small banks to borrow,” said one trader. “There were people begging for liquidity.” On Monday, some small, rural banks failed to make good on short- term funds borrowed from other lenders, according to traders and banking executives….the PBOC injected an estimated 300 billion yuan ($43.6 billion) into the financial system via short-term funding facilities, the people said, in an apparent effort to prevent the defaults from evolving into a full-blown credit crunch.”
For that reason, it is not really a bellwether market indicator, but a monetary tool controlled by Beijing. This has been stated to me in several meetings with banks and bank officials. The PBOC uses the interbank rate to “shock” the system, in their words.
In addition, traditionally, the academic literature has noted there has been little relationship between the interbank market and the macro-economy. As noted by the IMF in a 2014 paper: “We argue, using a theoretical model and empirical analysis, that the regulation of key retail interest rates diminishes the ability of the market determined rates to act as independent price signals, or as benchmarks for use in asset pricing and monetary policy. “ (What Drives China’s Interbank Market? Porter and Xu, 2014).
As for forex flows and the RMB rate, obviously a decline in reserves and the RMB would be a clear indication of systemic weakness. If there were to be drastic declines in either, this would be a significant problem for China. However, once again, these are relatively controllable by SAFE and the PBOC. So far, they have been successful.
Real Economic Policy Occurs Behind Closed Doors
More broadly, all three indicators can be monitored in real time and are widely watched globally — and for that reason the leadership is determined to avoid any large scale volatility in them. The stock market crash of 2015 only reinforced this view within the top leadership. I have seen time and time again areas where publicly stated policy, and relevant data, is steered in one direction, while actual economic activity occurs in another. Household leverage is one example as it is not captured by the data. Another is the use of equity investments by banks instead of loans as these are not closely monitored and it is unclear where the funding is going (most likely the property market). A third are the areas such as publicly stated restrictions on mortgages while the CBRC quietly allows banks to increase loans to property developers. (This was told to me last year by a senior bank official in Beijing.)
Administered rates — and more important, flows — are the real determinant of liquidity of the system. These are easier to control behind the scenes without the data immediately hitting the Bloomberg screens. The rates are almost completely hidden — who knows what an SOE is paying for its bank loans? As for flows, theyare partly illuminated in Total Social Financing, and bond and equity issuance, and WMPs, but this data is often lagging, and additional flows in the form of investments, accounts receivables, etc., are not provided in real time or detailed in financial statements. In addition, off-balance sheet leverage, particularly now in households, is not tracked at all.
Stresses Seen in Defaults
Thus, stresses in the financial system will occur through small-scale defaults in WMPs, corporate bond defaults, and even corporate defaults in the courts. These will increase in size and frequency over time (in my view) but will be absorbed by larger actors in the system. Information will leak out in ancillary data such as the number of defaults in the courts, a rise in WMP defaults that are informally reported, and corporate loan defaults that may show up in court data or in bank data. We may even see some local governments running into problems. This will affect activity in the real economy in commodity consumption, housing construction, and overall GDP. But it may not immediately appear in the stated data. Instead, we believe that WMP and corporate defaults, often not officially reported, will be stronger indicators of true weakness in the economy.
Unfortunately, this process is similar to what the early star gazers did. They couldn’t measure the stars directly. So they estimated the size and age of stars by analyzing the color of the light they emitted. White-hot stars threw off blue and ultra-violet waves. When it comes to economic policy in China, outsiders are in the position of stargazing.
END
https://www.bloomberg.com/news/videos/2017-06-22/orient-s-collier-anbang-too-big-a-company-to-fail-video
Zheshang Bank
How Chinese Banks Accelerate Risks
We have long maintained that the smaller Chinese banks have the highest risk profiles. This is due to their aggressive expansion of their balance sheets using risky sources of capital, along with their reliance on a much smaller market with less opportunity to spread the risk geographically. Zheshang Bank, which listed in 2016 and has a market cap of $9.6 billion, is a clear case study.
Connie Bolland, founder and chief economist at Economic Research Analysis comments on Bitcoin surging to a new record high and says people’s increasing mistrust of central banks contributes to Bitcoin’s rise. Andrew Collier, managing director of Orient Capital Research says competitive Chinese airlines and banks shrinking travel budget make it difficult for Cathay Pacific to increase its profit margin.
http://www.rthk.hk/radio/radio3/programme/money_talk
“Shadow Banking and the Rise of Capitalism in China.” by Andrew Collier. Palgrave Macmillan, now available on Amazon.
My book, Shadow Banking and the Rise of Capitalism in China, has been published by Palgrave Macmillan. It is available on Amazon.
“Shadow Banking and the Rise of Capitalism provides a highly accessible and well-informed overview of the evolution of informal finance in China during the reform era. Boldly articulated, based on decades of first-hand experience, and infused with memorable insights, Collier’s book will appeal to industry observers and students of China’s political economy.”
– Kellee S. Tsai, author of Back-Alley Banking: Private Entrepreneurs in China, Chair Professor & Head, Division of Social Science, Hong Kong University of Science & Technology
“This is not a simple story to tell because it needs to combine macroeconomic insights with knowledge of different kinds of shadow banking products and finally a human dimension. Collier is very well equipped to do so. “
– Victor Shih, author of “Factions and Finance in China: Elite Conflict and Inflation,”
Assistant Professor of Political Economy at the University of California at San Diego.
