As the leadership of the Chinese Communist Party signals an increasing desire to expand the country's international activity and influence, the country's largest banks, which are all state-controlled, have stepped up their foreign lending even as credit growth is kept in check at home.
Figures from S&P Global Market Intelligence and Moody's indicate that overseas lending has gathered pace in 2017, in what observers are saying is a politically driven strategic shift.
"A lot of the increase in foreign lending is to do with the Belt and Road project," said Giles Chance, an adjunct professor of business administration at Dartmouth College in the U.S. "Banks tend to support government projects."
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The Belt and Road is a foreign policy initiative aimed at building a corridor of transport and logistics infrastructure from Beijing to Europe, through developing Central Asian and African countries, to ensure the smooth transit of China's exports to their target markets.
Overseas lending by the three so-called policy banks — China Development Bank, Export-Import Bank of China and Agricultural Development Bank of China — has experienced strong growth in recent months, with Belt and Road-related finance and credit supporting Chinese corporations' foreign expansion reaching 16.3% of these banks' total assets at the end of the third quarter, Moody's said Dec. 14.
But the strategy is a risky one for the banks, as losses may start to materialize on some Belt and Road loans given that they involve higher-risk countries, the rating agency said.
"The [Belt and Road Initiative] faces significant implementation challenges, and this will result in increased exposure to countries with comparatively poor credit profiles, including weak financial strength, high susceptibility to event risk and an unfavorable business environment," it said.
Within China, the government is keen to introduce more market discipline in finance and wean both the private and public sector off excess debt, which stood at 256% of GDP at the end of September, according to the Bank for International Settlements. Chinese corporates hold debt equivalent to 160% of GDP, according to the Financial Times, making them the most levered in the world.
It has become the government's objective to rectify this imbalance, said Professor Chance in an interview.
"The government over the last six months has put an end to continuous expansion with borrowed money of conglomerates like Anbang Insurance Group Co. Ltd. and HNA Group Co. Ltd.," he said. "[Regulators] are introducing the idea that there may not be a bailout if things go wrong."
After decades of state backing, banks are being forced to accept the notion that their biggest clients might default and leave them on the hook, he said.
China has said it will support foreign investment linked to the Belt and Road initiative, but will restrict overseas lending linked to real estate, entertainment and other industries in countries with which it has no diplomatic relations.
Domestic lending by China Construction Bank Corp., Agricultural Bank of China Ltd., Bank of China, Bank of Communications Co. Ltd., Industrial Bank Co. Ltd. and China CITIC Bank Corp. Ltd. has grown at a relatively modest clip in recent months, data compiled by S&P Global Market Intelligence shows. On the other hand, the same banks dramatically increased lending outside China since the end of 2015, a trend that has continued in 2016 and 2017.
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The change has not escaped the attention of global regulators in Basel. In November, the Financial Stability Board put Bank of China and China Construction Bank Corp in the second category of global systemically important banks for the first time, on a par with the likes of U.K.-based Barclays Plc, recognizing their growing complexity. They must now hold more high-quality capital against potential losses.
But the foreign expansion could bring benefits, especially for Bank of China, which derives more than 35% of gross profits from overseas banking. Rising interest rates and growing offshore low demand, helped by a recovery in exports and rapid overseas expansion of Chinese firms, could help the bank, according to Iris Tan, a bank equity analyst at Morningstar.
It is also less impacted by tighter regulations because of its more diversified geographic mix, the analyst said.
Fearing an economic crisis and the bursting of a property bubble in the big cities, Chinese regulators have cracked down on leverage all through 2017. Credit growth in mainland China fell in November to 13.5% from 14.1% the previous month, according to a Dec. 14 analysis by French bank Société Générale, the slowest growth in two years.
"[Domestic] credit growth is well on a downward trend, albeit a modest one, which, nevertheless, still points to growth deceleration next year," SocGen said. "Every single channel of nonbank credit creation — including trust loans, entrust loans, undiscounted bank's acceptance bills and bond financing — was slower than a year ago."
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Meanwhile, the government will continue to curb shadow banking in order to maintain financial stability, said Nicholas Zhu, a senior analyst at Moody's.
China has made regulatory changes throughout 2017 in order to curb so-called shadow banking, which is the widespread practice of lending through off-balance sheet investment vehicles. Regulators have issued rules discouraging banks from borrowing money to invest in bonds.
For the first time since 2012, the country's economic output grew faster than its shadow banking sector in the period between January and June 2017, the rating agency noted. Shadow banking assets formed 82.6% of GDP at the end of June.
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