Chinese banking crisis “not a concern”, say Aberdeen and Hermes
20 January 2014
Devan Kaloo and Gary Greenberg say China’s banks are well capitalised and have little exposure to the massive number of poorly regulated loans made by wealth managers.
Fears over the tapering of the Fed's QE programme, China's economic slowdown and its banking system meant that the MSCI China performed poorly in 2013.
Performance of indices in 2013
Source: FE Analytics
One headwind was caused by the People’s Bank of China's attempt to crack down on the country’s shadow banking system, made up largely of wealth-management products offering poorly regulated loans to businesses and consumers.
There were short-lived liquidity crises in June and December as the SHIBOR [Chinese inter-bank lending rate] spiked, causing concerns about the health of the highly leveraged banking sector and its exposure to a booming property market.
While a number of industry experts warn that this could be a prelude to a future banking crisis in China, Devan Kaloo (pictured), head of global emerging markets at Aberdeen, says the country’s financial system is still strong.
“We don’t expect a collapse of the financial system any time soon, and that’s because the banking system remains fairly well-capitalised, so it’s not reliant on external liabilities,” Kaloo said.
“The loan-to-deposit ratio is relatively low, below 100. This means they are funding growth in loans by taking deposits domestically, so they are much less likely to face the liquidity issue, one of the main problems that faces banking systems.”
Kaloo expects further volatility from China in the short-term because the lofty property market will have to correct. However, he says this will have no lasting implications.
“Yes, the property market has overheated in certain areas and yes, perhaps property prices will come down, but it won’t necessarily have a major detrimental effect on the banking system, primarily because the banking system hasn’t been the main funder of property prices.”
“Overall mortgages in relation to residential sales are only about 30 per cent. Most property sales in China are done with cash.”
“Now that has consequences for domestic spending as it crowds out the other bits, which is one reason why domestic consumption isn’t as high as it should be, but certainly it doesn’t have the same negative impact on the financial system if and when property prices start to correct,” he added.
Greenberg, who runs the £213m Hermes Global Emerging Markets fund, is more bullish on China than most of his peers and has a 12 per cent overweight position in his portfolio as a result.
The manager says that the authorities plan to crack down on the country’s shadow banking sector – which accounts for close to a third of China’s total credit in circulation – although this will take time to iron out.
“It is still an issue as China is going through a transition,” Greenberg said.
He points out the state-owned Chinese banks are refusing to guarantee the loans of investors who borrowed from wealth management companies, limiting their liabilities.
“Investors thought they would, but the banks have turned around and said 'no we are not, go and take your loans',” he said.
“This is very positive, as it means the banks aren’t on the hook. However, this is going to be difficult for people to recognise and the number of non-performing loans is almost certainly going to go up,” he added.
Greenberg says that this isn’t something investors should be overly concerned about. He agrees with Kaloo, saying that the actual Chinese banking sector is in good shape and that although the process of sorting out the shadow banking crisis could well be arduous, it will eventually make the financial system healthier.
Nevertheless, he expects returns from the country’s equity market to remain sluggish for the time being.
“There are a number of positives,” Greenberg said. “Chinese banks' capital ratios are extremely high. It is also positive that the Chinese authorities are being almost draconian in there process of liberalising their economy.”
“However, until the process is completed, I wouldn’t expect a re-rating in Chinese equities. Unless you are looking at Russia, China’s stock market looks very cheap – but it could get cheaper. I still think that over the long-term it is the single most interesting stock market.”
“On a 12-month view, though, it is difficult to say how Chinese equities will perform,” he added.
Investors in China have been well-rewarded over the past decade or so.
According to FE Analytics, the MSCI China index has returned close to 250 per cent over 10 years while popular funds have made even more – FE Alpha Manager Martin Lau's First State Greater China Growth portfolio, for example, has returned 365.63 per cent over this time.
Performance of fund vs index over 10yrs
Source: FE Analytics
However, GDP growth in China has been falling over the last few years and recent data shows it slowed to 7.7 per cent in 2013.
Craig Botham, an emerging markets economist at Schroders, expects this trend to continue.
“While China managed a fairly strong end to 2013, we see weakness ahead,” Botham said.
“Though exports should perform well as the global recovery plays out, the outlook for investment is bleaker than it has been for years.”
“The push to tighten credit and rebalance the economy could be claiming its first victims, though we expect reformers will slow their pace if the body count climbs too high.”
Greenberg says that although the long-term outlook for China is still healthy, investors need to look at the country differently from the way they have done in the past.
“The signs are beginning to look very encouraging,” Greenberg said.
“The authorities know that the past model of borrowing mostly from your own country and increasing production at any cost to fill over-stuffed western consumers with TVs is not sustainable.”
“For China to be more sustainable, it has to take on less debt, grow at a slower rate and its companies need to earn their cost of equity. However, the government is moving to have its market play a more decisive role,” Greenberg added.
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