Tyler Durden: China is desperate to solve several problems it has due to its debt to GDP ratio being north of 300 percent. It may have found a pretty unconventional one by letting companies become banks, according to a report by the Wall Street Journal.
With profits headed south, heavily indebted Chinese heavy-machinery giant Sany Heavy Industries said this week it won approval to set up a bank in the Hunan Province city of Changsha. With 3 billion yuan ($450 million) of registered capital, it will be a relatively large institution as Chinese city-based banks go. Sany plans to join forces with a pharmaceutical company and an aluminum company.
Sany already operates an insurance and finance division with the goal of internal financing and insurance services for clients.
One problem is that companies are defaulting on bond payments and there is no adequate resolution mechanism for bad debts, at least according to Goldman Sachs.
“A clearer debt resolution process (for example, how debt restructuring on public bonds can be achieved, how valuation and recovery on defaulted bonds are arrived at, the timely disclosure of information and clarity on court-sanctioned processes) would help to pave the way for more defaults, which in our view are needed if policymakers are to deliver on structural reforms,” the investment bank writes in a note.
By becoming or owning banks, the companies can just shift debt around different balance sheets to avoid a default, although this is probably not the resolution that Goldman Sachs had in mind when talking about structural reforms.
Another problem is that the regime has more and more difficulties pushing more debt into the economy to grease the wheels and keep GDP growth from collapsing entirely.
China needs 11.9 units of new debt to create one unit of GDP growth. At the same time, the velocity of money or the measure of how often one unit of money changes hands during a year has fallen to below 0.5, another measure of how saturated the economy is with uneconomical credit. If the velocity of money goes down, the economy needs a higher stock of money to keep the same level of activity.
So if companies can’t pay back loans, old banks don’t want to give out loans, and consumers don’t want to circulate the money, you can just let some companies become banks to prevent them from defaulting and maybe even issue new loans to themselves.
It would not be the first time China has tried a circular financial arrangement to solve some structural issues.
Sany Not Alone
According to the Wall Street Journal report, the Sany Heavy Industries case is only one of a few. Other companies in the tobacco and travel sectors, for example, have taken over banks or formed new ones.
ChinaTopix reports that the China Banking Regulatory Commission (CBRC) has already awarded five licenses for private banks and received another 12 applications during the past year. It also mentions that industrial firms are behind this move:
“One bank, Fujian Huatong Bank, which has a registered capital of Rmb3 billion ($450 million), was promoted by 10 Fujian-based companies in different sectors, including retail, manufacturing and real estate.”
We don’t know if the regulator had this in mind when they launched the initiative to boost private banks in China in 2014 in order to improve lending to the technology sector, but it did explicitly mention that private companies should form banks.
“Qualified private enterprises shall be encouraged to set up private banks. The innovation of products, services, management, and technology by private banks will inject new vitality into the sustainable and innovative development of the banking sector,”the CBRC states in an undated report.
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It remains to be seen whether this is a long-term sustainable solution.
The iShares FTSE/Xinhua China 25 Index ETF (NYSE:FXI) closed on Friday at $35.93 per share, up $0.53 (+1.50%). The largest Chinese equities-focused ETF has risen 1.81% year-to-date, versus a 7% gain by the S&P 500 in the same period.
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