While it is the Chinese stock markets – predominantly A-shares – that have been occupying recent headlines, there is another story brewing behind the Great Wall that has slipped under the radar.
With Chinese institutions representing four of the seven largest global banks – the Industrial & Commercial Bank of China and China Construction Bank Corporation occupying first and second – Dehn, Ashmore ’s head of research, believes that government-led reforms are paving the way to a lucrative future.
“For some time, Chinese policy-makers have been engaged in a complete overhaul of the banking system,” he said.
“Without a reduction of the banks’ large exposure to local government loans China’s ambition of becoming a consumption-led economy cannot be fulfilled, and room needs to be made for conventional consumer and corporate finance activities to stimulate the consumer economy.
“The transformation of China’s banks into providers of consumer credit and private sector corporate finance is now well underway. Banks are also emerging as providers of more sophisticated asset management services and more diversified savings products. In short, China’s banks are becoming much more like conventional, Western-style banks.”
One of the key aspects of this transition, says Dehn, is Chinese banks swapping their non-tradable local government loans for tradable municipal bonds with varying maturities.
However, while Dehn is optimistic in the long-run, he concedes that the process of converting around RMB 11tn of local government bonds is not without its risks, and with RMB 2tn already swapped and scope for a further RMB 8tn, this municipal bonds trade could spark medium-term banking sector losses.
“Eventually, the municipal bond market in China will reach $1.7trn (£1.09tn), making it larger than the entire dollar-denominated EM corporate debt market, and roughly half the size of the US municipal bond market.
“These bonds on the bank balance sheets will likely be off-loaded into a rapidly growing asset management industry within which China’s banks themselves will play an important role. As such, China’s banks will be instrumental in ‘discovering’ the appropriate market price for individual muni bonds as they become tradable.
“Municipal bond spreads will gradually come to reflect the quality of individual local governments’ management, transparency, etcetera. The process will initially mean higher borrowing costs for local governments and potential losses for banks to the extent that the loans are not marked at fair value.”
Joshua Crabb, Old Mutual Global Investors’ head of Asian equities, believes that one potential risk could stem from decreasing Chinese consumer spending.
