By staff reporters Wen Xiu, Fang Huilei and Wu Ying
(Caijing Mazagine)China's banks approved a combined 4.58 trillion yuan in new loans during the first quarter – a remarkable cash surge equal to the total amount of bank lending for all 2008.
It shocked some to see the credit floodgates open smack in the middle of a global financial crisis. Even more surprising was that, a month into the second quarter, lenders were showing no sign of letup; neither the market nor government policies appeared to be putting on the brakes.
One of the only hints of a possible slowdown came April 15, when China Banking Regulatory Commission (CBRC) Chairman Liu Mingkang called for "moderating" the loan pace.
But the loan writing has continued, raising key questions for China's economy. Has this trend -- fanatical to some, sensible to others -- helped ease deflation and actually bolstered the economy? Or has it raised inflation risks and damaged financing mechanisms?
To what extent will bank lending grow or contract in the future? And what may be the consequences for China's financial markets and Main Street economy?
The country's key policymakers are offering few answers to these and other difficult questions. Neither are they willing to guess. "It's still too early to come to a conclusion," declared Yi Gang, deputy governor of The People's Bank of China, at a recent press conference.
It may be hard to tell whether the credit rush will help China's economy recover from the effects of the global downturn. But risks and opportunities are becoming increasingly clear.
Through most of April, some large banks were scaling back on new loans. The net effect, however, was zero.
According to a senior executive at a large commercial bank, April lending overall exceeded February's level. What appeared to be a slowdown actually may have been just a temporary pause by banks following their lending craze in March.
Lending reached a peak during the last two days of the first quarter, bringing total loans for March alone to 1.89 trillion yuan. That beat the monthly record set in January -- 1.62 trillion yuan.
According to internal data, only one of China's big Four Banks -- China Construction Bank -- stopped issuing loans for a short period during the first quarter. The pause came on the last two days of March.
But other members of the Big Four club -- ICBC, Bank of Agriculture and Bank of China -- actually accelerated credit outlays as the quarter drew to a close. The largest single loan was 120 billion yuan.
China Construction Bank, according to an inside source, had decided to curtail what it considered excessive lending by its local branches, which were using credit programs to increase market share. Credit reviews were tightened, and lending shrank to extremely low levels.
But the move was a minor blip. A risk management executive at another commercial bank said, for now, none of the banks can afford to sit on the sidelines in the current race for loan customers.
Data indicates that the Big Four banks account for 50 percent of all loans in the industry– and none is daring to relinquish a centimeter of market share.
More than business is at stake. Top executives at the Big Four banks are also government officials with vice minister-level positions. So in addition to caring for their banks, they are responsible for supporting the central government's economic stimulus policy.
As the main lender for infrastructure projects -- a major component of the 4 trillion yuan stimulus package announced last fall -- China Construction Bank wrote an enormous number of loans at the beginning of this year. In March, the bank slowed its pace, but still managed to lend 170 billion yuan.
Other banks stepped up the pace. In particular, ICBC wrote about 310 billion yuan in new loans, and Bank of China issued loans worth 226 billion yuan in March.
Historical data indicates commercial banks tend to be more willing to lend during the first quarter each year. But the situation is a bit different in 2009.
One reason, according to a corporate loan executive at a large state-owned bank, is the influence of local governments on banks. Most local governments set criteria for regional branches of the big banks. For example, they decide how much the banks should provide to support local economies, making these evaluations public on a regular basis and, thus, putting pressure on the banks.
But pressure from the central government in Beijing may be even greater. According to a local branch executive at a state-owned bank, local branches have been asked by central authorities to increase lending several times since the beginning of the year.
Meanwhile, the banking industry is trying to explain the credit craze in another way: They, along with some companies, have said they're worried that the central bank may soon tighten credit policy in reaction to loose lending in the first quarter.
The conflicting signals can be even more bewildering considering that the State Council, China's cabinet, as well as government monetary authorities appear completely at-ease over the soaring credit levels.
The People's Bank of China held a meeting April 22 with senior executives in charge of lending at major banks. Yi, the deputy governor, told the gathering that rising credit since November 2008 has had good and bad dimensions, but that positive aspects overshadow the negative.
He also said the central bank would not restrict the scale of lending.
"For now, rapid credit growth has more merits than defects," Yi said, according to one meeting participant. "But time is needed to test whether it is a magnifier or a stabilizer."
This source assumed, based on the tone of Yi's remarks, that the central bank would continue following a relatively loose credit policy, at least for now.
A day after the meeting, an editorial entitled To Implement Moderately Eased Monetary Policy was posted on the central bank's Web site, affirming the source's assumption.
Yi said in the article that merits of large-scale lending during the financial crisis outweigh the disadvantages. Credit lowers anticipation of deflation and stabilizes capital markets, he said. It also speeds up inventory cycles for companies. And higher loan levels can bolster public confidence in China's stable, fast-growing economy.
Yi said authorities should think about the sustainability of rapid credit growth and any negative ramifications. He concluded that future lending activity should be stable and rational.
Yi is a scholar-turned-official with a background in macroeconomic studies. He predicted the 1998 deflation crunch in the early stages of the Asian financial crisis, and contributed to timely adjustment of the nation's monetary policy. These contributions helped him rise from an academic post as an overseas returnee to chairman of the Monetary Policy Department at the central bank, and later deputy governor in charge of monetary policy.
His published works include The Process of China Going Monetary, which explains critical issues surrounding China's ability to maintain double-digit money supply growth while avoiding serious inflation.
The nation's monetary policy is not determined solely by the central bank, but Yi's recent discussions on the merits of fast growth in lending serves as a window to Beijing's overall attitude.
Credit is also seen as a way to boost economic growth. As Yi pointed out in his essay, companies that offload stock and normalize inventories consider credit helpful for manufacturing recovery and business cycle adjustment.
Indeed, writing loans "to secure growth," provided that "risk controls are in place," has been a stated Beijing objective since November.
But the government's policy may be putting economic growth ahead of structural adjustment and risk management.
Chinese banks have not followed the path of overseas markets, where lending has been cut or frozen. Their extremely active lending quarter has shielded the Chinese public from feelings that a recession is under way. Public confidence in the economy has even strengthened in recent months.
Yet many bank executives and regulatory officials interviewed by Caijing expressed concern over the efficiency and effects of the lending spate, as well as its impact on economic structural adjustment.
"Will the economic stimulus plan disrupt the self-adjusting nature of the economic cycle?" asked a state-owned bank executive. "The biggest contribution made by an economic downturn is survival of the fittest, along with structural adjustment."
These effects are particularly clear from a microeconomic perspective. A source close to Beijing authorities pointed out that local economies have seen overcapacities in some industries and have faced rising pressure due to excessive inventories.
For example, the nation's steelmaking capacity was 660 million tons in 2008 -- an overcapacity of more than 160 million tons. After steel inventories bottomed out in December, they started to rise again this year.
Steel inventories grew as much as 86 percent in the January-February period. And by the end of March, the composite price index for steel had fallen 97.6 points, down 10.7 percent from early February's level.
A jump in credit lending also poses remarkable challenges for bank risk management. A corporate loan executive at a state-owned bank said, "For the time being, project lending and liquidity lending control have been loosened to an extreme."
The hint of moderation from CBRC's Liu, who said "the pace of credit lending should be moderated" at a recent briefing on first quarter financials, came with an explanation that new risks can mount when risk management is relaxed and imprudent behavior creeps into the system during a period of soaring credit.
According to Liu, most first quarter loans were issued for local infrastructure projects, local investment and financing platforms. A monetary official at a local government said, under condition of anonymity, that infrastructure credit accounted for 70 percent of the new loans.
Although this infrastructure explanation may settle fears about excess lending to future overcapacity, it has not assuaged concerns over other risks stemming from local government projects.
The corporate banking source said, "Some government-backed investment and financing platforms have rather high levels of liability, and some have hastened the pace of debt increase." But government fiscal abilities are limited, and fiscal revenues have sharply declined in the economic downturn.
"Although it is challenging for banks to assess the true fiscal condition of local governments, excessive liabilities only steal from the future,"the banker said.
On the other hand, the big jump in credit lending has helped to quickly stabilize the capital market. The Shanghai Composite Index has climbed 600 points, or nearly 30 percent, so far this year. And any talk of an equity bubble has been muted.
"Chinese authorities now think some bubbles are better than none," said a research chief at an international investment bank.
Credit is also seen as a deflation fighter. Deflation is considered more damaging to businesses than mild, single-digit inflation. And when commodity prices sink, deflationary pressure far exceeds the threat of inflation.
When the Chinese economy slumped in 1998 and 2003, state economic stimulus plans led to new rounds of rapid growth. If the world economy recovers from the current crisis and external demand rises again, China will have realized its goal of adjustment by ironing out wrinkles during the darkest period of the economic cycle.
Richard W. Fisher, president of the Federal Reserve Bank of Dallas, said in an interview with Caijing that corporate credit demand in China is less sensitive toward interest rate policy than in the United States. Therefore, the Chinese government can more precisely control the scale and direction of credit expansion, and may intervene in microeconomic activities.
Bankers that are writing the loans clearly understand that bank financial performance is closely related to the economic cycle.
Several senior executives at state-owned banks told Caijing that, to prevent a rise in non-performing loans in the wake of the latest lending surge, the economy must be kept from deteriorating. They said banks are now in a good position to support economic development.
Indeed, hints of economic recovery appeared in the most recent macroeconomic data. First quarter indicators for fixed-asset investment, retail sales and industrial production were positive.
Fixed-asset investment grew 28.8 percent year-on-year in the first quarter. In particular, new urban construction projects nationwide rose 87.7 percent year-on-year, after declining 4.4 percent in the first quarter 2008 year-on-year.
Beyond the national statistics, however, the enormous amount of new lending has focused attention on the financial activities of local governments. Not all of the talk is positive.
For example, local governments have come under fire for using land as a capital base. A former central bank governor, Dai Xianglong, was being critical when he said at this year's Boao Forum for Asia that some local governments "have used income from land leasing as a capital base or guarantees, which are special loans as foreign financial institutions see them."
Risks attached to local investments and financing platforms mainly stem from the capital bases for projects. The greatest dangers surface when a capital base is lacking.
Beijing regulators have signaled that the capital bases for some projects are seriously inadequate. This came when regulators gave a green light to bridge loans for financing projects approved by the National Development and Reform Committee, which plans to lower capital base requirements for certain projects.
At the same time, regulatory authorities are concerned about loan misappropriation at the local level.
Several bankers told Caijing that many local banks have been under pressure to issue loans for local projects in response to the central government's economic stimulus plan. Now, some fear that cash may have been misappropriated.
Such abuse could be tied to bank loans issued to meet local liquidity needs, to back letters of credit, and for buying securities.
Moreover, a corporate banking executive said some big enterprises have been known to concentrate capital by pooling their loans and recycling the cash. When that happens, banks lose control over the direction of their loans.
And when big companies are unwilling to increase capital investments, citing concerns about the economic cycle, borrowed money is likely to flow into the stock market and real estate for speculation.
Indeed, the executive said controlling capital flow and credit lending are long-term issues for the banking system.
How much misappropriation may be linked to this year's increase in lending activity? That answer may never come.
But as the international investment bank executive explained, "For a long time into the future, it is very likely to have economic recession together with big, crazy bubbles in the stock and real estate markets."
"This will be a new, messy and distorted situation."
1 yuan = 14 U.S. cents