Some super bears are now expecting an imminent collapse of China's banking system and currency
China's banking sector is now so big that if it even if it lost only of 10% of its outstanding loans to defaults, that would be the equivalent of wiping out about 30% of China's annual GDP, according to UBS economist Tao Wang.
That scenario would require an immediate bailout of China's banking system, which is now the largest in the world, Wang says, so "some super bears are now expecting an imminent collapse of China's banking system and currency."
This chart, from Wang's February 15 note to investors, shows the current state of China's banking loan assets, which stand at 290% of GDP:
But don't freak out, Wang says. The China "super bears" are wrong and everything is going to be just fine.
Wang's discussion of the state of the Chinese financial sector comes in a note titled "Do the Facts Support the Super Bears?" The note is crucial reading for China watchers because it states in simple, stark terms just how big Chinese banking credit actually is, in the context of the flight of capital from China right now.
It then adds a nuanced understanding of how Chinese banking works - i.e. not the same way as it does in London and New York. Wang concludes that fears about the low-quality credit market in China being so large that it could create a new Great Financial Crisis (GFC) globally are overblown. We'll explain why in a moment.
But first, here is the problem with China's banks, as stated by Wang:
- China's banking sector is 340%* of GDP, 10% loss would be over 30% of GDP or more than $3.5 trillion, which would require an immediate and large bail out.
- ... some super bears are now expecting an imminent collapse of China's banking system and currency. The latest super bearish view goes like this:
- 1) the RMB has appreciated by over 40% and become significantly overvalued on a real effective basis, requiring a huge depreciation to correct China's imbalances;
- 2) the rapid credit expansion of the Chinese banking system will result in unprecedented losses which requires an immediate large bail out;
- 3) China would need to use FX reserves or embark on major QE to recapitalize its banks;
- 4) China's official FX reserves include CIC [China Investment Corporation] holdings and policy bank recap funds, and are already inadequate.
But none of that is going to happen, Wang says, because China will "muddle through." The government has the ability to restructure, renegotiate, and generally stave off non-performing loans that would be poison inside a more private system that had to answer to shareholders (emphasis ours):
China's banking system still enjoys ample liquidity - the most important thing for banks - in the form of cheap deposits thanks to a high saving rate and under-developed financial markets. The Chinese government has extensive control and ownership over/of banks as well as SOE and local government borrowers, and has always made depositors whole. These combined factors mean that recognition of non- performing loans will be slow, banks and debtors will be asked to renegotiate and restructure debt rather than engage in a rapid write-off. We expect banks to gradually raise capital through various means (policy banks, accounting for about 10% of financial system assets, have already received government recapitalization in 2015), but do not see the need for a large bail out immediately.
*Wang's note describes bank assets as both 290% and 340% of GDP. It is not clear why. We will update this story if we can find out.