China’s economy, mired in a property slump and beset by deflation, requires a low interest rate environment to stimulate growth. — Bloomberg
BEIJING: China’s regional lenders are facing growing risks in the nation’s US$4.3 trillion sovereign debt market after an unprecedented bond rally this year prompted a slew of warnings from the central bank.
The lenders, some with over 50% of their assets in bonds, are bracing for potential sales by the People’s Bank of China (PBoC), which is seeking to control risks and cool the market.
The banks are divided over whether to keep chasing the rally or trim their positions, according to interviews with more than a dozen bankers who requested anonymity discussing a private matter.
Over the past year, regional banks have been the most aggressive buyers of Chinese bonds to make up for profits lost on their bread-and-butter lending businesses, as competition intensifies amid weaker loan demand.
That put them in the crosshairs of regulators seeking to limit risks at these financial institutions, especially after the collapse of Silicon Valley Bank, which had piled into US treasuries before rates rose.
The PBoC’s local branches have dispatched teams to some lenders to check on their bond holdings and transactions, said the people, asking not to be identified.
Jason Bedford, a former analyst who predicted troubles at China’s regional banks in 2019, said they’re buying government bonds “like there’s no tomorrow.”
“As they push more of their balance sheet into sovereign debt, downward pressure on yields is going to continue,” the former analyst with Bridgewater Associates and UBS Group AG said, noting the banks’ outsized role in determining yields.
“That is difficult for any central bank to control.”
Chinese bonds have been among the world’s best performers this year as the central bank lowers interest rates to revive growth in an economy battered by a housing slump and weak consumer demand.
The Bloomberg China Aggregate Total Return Index has risen 4.6% this year, compared with a 1.06% gain in a similar US gauge.
The rally is proving attractive for regional lenders, raising concerns from regulators that they’re exposing themselves to excessive risk if the market turns.
The bond surge has pushed yields lower, meaning banks are buying new bonds with lower interest rates, eroding profit margins.
“Yields on China rates still have a ways to go down,” Bedford said. “So you’ll have a short-term sugar high from the mark to market gains, but as you go to buy new rate instruments, you’ll get ever lower yields, which will squeeze that interest margin.”
Bond holdings at listed city and rural commercial banks, mostly sovereign debt and quasi-government bonds, accounted for about 27% of the group’s total assets at the end of 2023, according to data compiled by PricewaterhouseCoopers (PwC) LLP.
That ratio likely moved higher in the first half, PwC said. That compared with bond exposure of 25% and 22% at big banks and joint-stock lenders, respectively.
Dongguan Rural Commercial Bank Co had almost 38% of its assets in bonds as of December, the highest among listed regional banks, followed by Bank of Hangzhou Co and Qilu Bank Co at 35% and 34%, respectively, public filings showed.
The holdings could be even higher at China’s vast and opaque network of more than 1,600 rural commercial lenders, with just 13 of them publicly listed.
Recent surveys by the PBoC found exposure at some smaller lenders topped 50% of total assets, people familiar with the matter said.
The PBoC didn’t immediately reply to a fax seeking a comment.
Some rural lenders have received orders to shorten the duration of their bond holdings, and the central bank has hinted that it may sell the securities to influence yields.
China’s economy, mired in a property slump and beset by deflation, requires a low interest rate environment to stimulate growth.
But rates can’t be so low that they hurt bank profits, lead to a debt-buying binge, or weaken the yuan at a time of US dollar supremacy. — Bloomberg
