China: Warning signs for financial sector - NAB

Gerard Burg, Senior Economist at NAB, sotes that the recent data from the Bank for International Settlements has raised concerns around China’s financial stability.

Key Quotes

“The ‘credit gap’ – a measure that seen as an early warning sign for financial crisis – has increased rapidly, and is three times higher than the ‘danger’ level.

The growing rate of the credit gap, and similar measures such as credit intensity, demonstrate that the efficiency of China’s debt is decreasing. Some lending to large SOEs is used to roll over existing debts, or continue funding uneconomic operation. This lending fails to add meaningfully to GDP, as well as crowds out other potential borrowers – usually private sector firms, who are either unable to access finance or seek higher cost funds from the shadow banking sector.

The IMF has warned Chinese authorities to address these issues – noting that banks are holding an increasing number of non-performing loans and that recent credit growth is exacerbating the problem. The Fund’s conservative estimate of China’s potential banking losses from bad corporate loans is 7% of GDP – with exposure to shadow banking increasing the risk.

We have previously noted concerns around China’s debt levels, and the difficult choices authorities face between short (slower growth) and medium term (potential debt crisis) challenges in addressing the issue.

That said, we do not anticipate a Chinese financial crisis in the short term. This largely reflects the low level of foreign debt, the still relatively restricted capital account and the level of state control in the banking sector. However, continuing to allow credit growth – particularly to highly indebted SOEs – adds to medium term risks for China.”