China’s own version of a banking problem

By Anjani Trivedi.For all the talk of China's post-Covid economic revival and sweeping changes at the top, Beijing's biggest problems are (still) its small and medium companies..As China walks a fine line with its 5% growth target, these firms have a big role to play: They make up large swathes of the manufacturing and industrial complex, contribute around 60% of gross domestic product, and account for a significant chunk of exports. Beijing began talking up measures to help small and medium enterprises, or SMEs, in January this year. President Xi Jinping has urged these businesses (like many times before) to hum along and churn out goods, promising backing..___STEADY_PAYWALL___.But SMEs remain stuck in the doldrums. As of February, a gauge of current performance, based on factors like production, new orders, investment, inventories and profitability, was close to multiyear lows. The upbeat growth rhetoric of late hasn't helped boost the mood..Going into the pandemic, these companies — largely manufacturers in cyclical sectors — were already weak. Then, at the height of the Covid measures, things got worse: Around 85% of businesses didn't have enough cash to survive a three-month shutdown, one survey showed. A top issue was loan repayment..Now, to keep production lines running and abide by Xi's directive, loans to companies are rising at the quickest rate in over a year and a half, outpacing those to households. That's mirrored at China's smaller, regional lenders, where assets are growing almost as fast as at their larger, state-owned peers that tend to serve big enterprises..The weakest of small corporates — starved for funding and unable to tap credit lines — have turned to the underbelly of the financial system once again: Shadow banking, long a form of off-balance-sheet funding for China's industrial complex. Riskier loans — made by trust companies that are funded by structuring such borrowings into wealth management products — are growing. The stock of entrusted debt — borrowing between companies with lenders in the middle as agents — has also ticked up. While they aren't close to the peaks of 2017, prior to an aggressive deleveraging campaign that took out many companies and bank-like institutions, the return to bad habits is worrying..Meanwhile, the city and rural commercial lenders aren't any better off than the SMEs. Smaller banks have typically been warehouses of bad assets. Their capital buffers are weak, limiting their ability to deal with troubled loans (in theory, from small troubled companies). Net interest margins are low and declining. Their governance and priorities, in many cases, are run locally and credit risk isn't always top of mind. Systemically fixing them and rooting out the rot hasn't happened..In February, Beijing put out stringent draft measures in line with global norms to help lenders classify assets by type of risk and size of business. A focus of these rules is to determine the overall ability of borrowers to repay their debt, not just a loan, indicating an increasing concern around companies' financial health, not just banks' books. However, as the global failures and rescues of the past month show, just knowing risks exist isn't enough. Under China's new super regulator, if institutions are pushed to actually do something about loans that are likely to go sour, then it'll be hard for lenders to absorb them. With the wobbly global banking system out there, it's unlikely Beijing will make any move that would shake confidence. These rules don't come until next year..Beijing now wants even more SMEs: It's hoping to spawn 150,000 "innovate" small enterprises and more than 10,000 "little giants" by the end of this year. Stuck in this doom-loop, it'll be hard for these new firms to get off the ground and for the old ones to survive. Without painful and surgical changes, their fate and their lenders aren't changing anytime soon. .Read more:.Putin tells Xi he'll discuss China's blueprint for UkraineSouth Africa's power woes: Lessons from China, Greece, and Colombia on how to fix Eskom's problemsGideon Rachman: World's democracies need to stick together, but a united front on Ukraine and China is getting harder.© 2023 Bloomberg L.P.

China’s own version of a banking problem

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