China’s looming banking crisis

China’s looming banking crisis

Good morning and welcome to today’s foreign exchange market commentary on Monday, the 1st of October.

On the surface, China’s banks seem to do just fine. The non-performing loans were estimated at about one percent while the top ten banks posted double-digit growth on an average in the first quarter. But the future may not be smooth sailing. Reason: property loans going sour and bad debts of local governments.

The heightened activity in the infrastructure segment over the past few years gave rise to local government financing vehicles, an off-balance sheet entity used to bypass borrowing limits. According to officials, Chinese banks have a total exposure of about $1.5 trillion in these entities of which about 20-30 percent are non performing. Private estimates are however, much higher.

The government has stepped up its effort to contain the problem. Some of the loans have been transferred to China Development Bank, a policy bank whose balance-sheet is now bleeding. Local bonds have been issued in certain provinces to replace bad loans where as guidelines have been published urging banks to roll over loans in some cases in the hope that growth will ease the problem. Bad loans worth $80 billion from commercial banks were transferred to the China Development bank alone in last year.

The real estate sector is another worry as it has a wide influence on the economy and hence difficult to contain that local government debt. Chinese government estimates suggest 75 percent of the loans are collateralised. However, the quality of collaterals is a big worry as are the government statistics. Also at six percent, China has one of the lowest capital reserve requirements among the emerging markets. If a tenth of total banking credits get sour over the next 18 months, all the profits and nearly forty percent of equity will be wiped out from the system. A credit crunch may be very much underway soon.

CURRENCY RATES OVERVIEW

GBP/EURO – 1.2563
GBP/US$ – 1.6135
GBP/CHF – 1.5185
GBP/CAN$ – 1.5871
GBP/AUS$ – 1.5581
GBP/ZAR – 13.3627
GBP/JPY – 125.55
GBP/HKD – 12.5079
GBP/NZD – 1.9477
GBP/SEK – 10.6034

EUR: The single currency had a mixed day on Friday as investors remained apprehensive despite Rajoy’s administration presenting a draft budget for 2013 that will cut Spain’s overall spending by EUR 40 billion. Street protests have been boiling over in Madrid and have hit investor sentiments, hurting the euro. The results of Spain’s bank stress-tests were in line with expectations with total capital shortfall pegged at EUR 59.3 billion. This came as a relief as Madrid has already received EUR 100 billion credit assurance for bank re-capitalisations. The GBP/EUR pair opens at 1.2535 this morning.

USD: Sterling struggled against the greenback on Friday despite the lack of tier-1 data from the UK. Data from across the border failed to cheer as well as US personal spending numbers and consumer confidence reading came in weaker than estimated. Also the Chicago Purchasing Manager’s Index reading for September was reported at 49.7, the lowest in past three years, showing manufacturing weakening in the Midwest. Markets will watch out for the non-farm payrolls data due on Friday. We have a raft of employment numbers from the US along with the BoE and the ECB policy meetings in what could turn out to be a busy week.

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Have a great day!

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