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He Xiaobei: Banking Should Brace for Latent Risks

Apr 11-2024   



How to make of the phenomenon that China’s financial industry is large in size is of significant value in understanding the role of the industry in the macro-economy as well as the way to set a policy path for realizing ‘a financially robust nation’, wrote He Xiaobei in Lang Run Column, a series of commentaries by NSD researchers. She is Deputy Director of NSD Macro and Green Finance Lab.

 

The value-added of China’s financial industry amounts to around 8% of GDP, close to the levels of the USA and the UK and considerably higher than that of manufacturing powerhouses like Japan and Germany. He Xiaobei’s research showed that the increase of value-added over the last decade has been driven by credit expansion, in the context that China’s financial system is dominated by banks. At the same time, she noted that the Net Interest Spread (NIS) has been shrinking.

 

She pointed out that the characteristics of China’s economic structure and macro-economic control give rise to the phenomenon in which the financial industry exhibits ‘counter-cyclical’ growth. She explained that China is capable of effectively implementing counter-cyclical credit policy, which means that it can boost bank credit expansion when the real economy slackens. Developed countries, however, can hardly do so. Therefore, the rise of the financial value-added points to macro-economic control that makes the financial industry to step up support to the real economy. Put differently, the ratio of financial value-added to GDP and the ratio of investment to GDP are the two sides of a coin, she said.

 

Long-term statistics show that when an economy develops to a certain stage, finance’s weight in GDP tends to surge as investment opportunities crop up. Judging from short-term statistics, a rise in financial value-added in a weak economy is not idiosyncratic to China and it is closely related to the ‘risk pricing’ by banks. He Xiaobei referred to the research by Andrew Haldane, former Deputy Governor or Bank of England, which indicated that current calculation method for banking’s value-added is plagued by the inexistence of risk adjustment and treatment. When an economy worsens and banks expect to have a large amount of bad debts in future, they raise credit interest rates (represented by NIS increase) to cover potential asset loss, and the resultant NIS increase is counted as their value-added. In other words, current statistical methods are likely to cause an artificial spike in banks’ value-added; the truth is that the banking industry takes on the risks of the real economy, but the risks are tallied up as banks’ value-added.

 

More importantly, ‘risk’ is a variable that eludes direct observation, leading to non-performing assets being ignored or hidden in statistics, said He Xiaobei. In an extreme scenario, banks might extend a new loan to a failing enterprise so that the latter can pay back a previous loan and interests. This was exactly what happened to Japan in the 1990s: growth in bank credit and value-added was merely a cover for risks of the real economy.

 

Though the Chinese economy has slowed down in growth in recent years, the ratio of banks’ non-performing loans also declined year by year, to 1.6% currently. For He Xiaobei, this doesn’t mean that the assets of Chinese banks are safe since the banks have inevitably taken on a disproportionately large amount of the real economy’s risks. Based on the state of local government debts, credit policy for emerging industries, and policy to prevent spillover of real estate risks, He Xiaobei believed that if economic growth were not robust enough in near to mid-term, the risk of non-performing assets would eventually show up in banks’ balance sheets, leading to capital write-down and a dent in credit expansion and even payment capacity.

 

Despite many factors that have contributed to banks’ relatively low non-performing asset ratio, firm’s debt settling capacity offers a good gauge of latent non-performing asset risks, said He Xiaobei. Since 2017, non-financial listed companies with an Interest Coverage Ratio (ICR) of less than 1 has shot up as a proportion of all non-financial listed firms, reaching 20% in 2022. This indicates a marked increase in the real economy’s debt default risk. Such risky debt has yet to be reflected in banks’ balance sheets. He Xiaobei said that whether China’s banks can withstand the onslaught of large write-down of non-performing assets deserves concerns. For her, a financial industry that cannot set price on risk poses the biggest risk for the macro-economy.

He Xiaobei: Banking Should Brace for Latent Risks

How to make of the phenomenon that China’s financial industry is large in size is of significant value in understanding the role of the industry in the macro-economy as well as the way to set a policy path for realizing ‘a financially robust nation’, wrote He Xiaobei in Lang Run Column, a series of commentaries by NSD researchers. She is Deputy Director of NSD Macro and Green Finance Lab.

 

The value-added of China’s financial industry amounts to around 8% of GDP, close to the levels of the USA and the UK and considerably higher than that of manufacturing powerhouses like Japan and Germany. He Xiaobei’s research showed that the increase of value-added over the last decade has been driven by credit expansion, in the context that China’s financial system is dominated by banks. At the same time, she noted that the Net Interest Spread (NIS) has been shrinking.

 

She pointed out that the characteristics of China’s economic structure and macro-economic control give rise to the phenomenon in which the financial industry exhibits ‘counter-cyclical’ growth. She explained that China is capable of effectively implementing counter-cyclical credit policy, which means that it can boost bank credit expansion when the real economy slackens. Developed countries, however, can hardly do so. Therefore, the rise of the financial value-added points to macro-economic control that makes the financial industry to step up support to the real economy. Put differently, the ratio of financial value-added to GDP and the ratio of investment to GDP are the two sides of a coin, she said.

 

Long-term statistics show that when an economy develops to a certain stage, finance’s weight in GDP tends to surge as investment opportunities crop up. Judging from short-term statistics, a rise in financial value-added in a weak economy is not idiosyncratic to China and it is closely related to the ‘risk pricing’ by banks. He Xiaobei referred to the research by Andrew Haldane, former Deputy Governor or Bank of England, which indicated that current calculation method for banking’s value-added is plagued by the inexistence of risk adjustment and treatment. When an economy worsens and banks expect to have a large amount of bad debts in future, they raise credit interest rates (represented by NIS increase) to cover potential asset loss, and the resultant NIS increase is counted as their value-added. In other words, current statistical methods are likely to cause an artificial spike in banks’ value-added; the truth is that the banking industry takes on the risks of the real economy, but the risks are tallied up as banks’ value-added.

 

More importantly, ‘risk’ is a variable that eludes direct observation, leading to non-performing assets being ignored or hidden in statistics, said He Xiaobei. In an extreme scenario, banks might extend a new loan to a failing enterprise so that the latter can pay back a previous loan and interests. This was exactly what happened to Japan in the 1990s: growth in bank credit and value-added was merely a cover for risks of the real economy.

 

Though the Chinese economy has slowed down in growth in recent years, the ratio of banks’ non-performing loans also declined year by year, to 1.6% currently. For He Xiaobei, this doesn’t mean that the assets of Chinese banks are safe since the banks have inevitably taken on a disproportionately large amount of the real economy’s risks. Based on the state of local government debts, credit policy for emerging industries, and policy to prevent spillover of real estate risks, He Xiaobei believed that if economic growth were not robust enough in near to mid-term, the risk of non-performing assets would eventually show up in banks’ balance sheets, leading to capital write-down and a dent in credit expansion and even payment capacity.

 

Despite many factors that have contributed to banks’ relatively low non-performing asset ratio, firm’s debt settling capacity offers a good gauge of latent non-performing asset risks, said He Xiaobei. Since 2017, non-financial listed companies with an Interest Coverage Ratio (ICR) of less than 1 has shot up as a proportion of all non-financial listed firms, reaching 20% in 2022. This indicates a marked increase in the real economy’s debt default risk. Such risky debt has yet to be reflected in banks’ balance sheets. He Xiaobei said that whether China’s banks can withstand the onslaught of large write-down of non-performing assets deserves concerns. For her, a financial industry that cannot set price on risk poses the biggest risk for the macro-economy.

 

He Xiaobei: Banking Should Brace for Latent Risks

Apr 11-2024   



How to make of the phenomenon that China’s financial industry is large in size is of significant value in understanding the role of the industry in the macro-economy as well as the way to set a policy path for realizing ‘a financially robust nation’, wrote He Xiaobei in Lang Run Column, a series of commentaries by NSD researchers. She is Deputy Director of NSD Macro and Green Finance Lab.

 

The value-added of China’s financial industry amounts to around 8% of GDP, close to the levels of the USA and the UK and considerably higher than that of manufacturing powerhouses like Japan and Germany. He Xiaobei’s research showed that the increase of value-added over the last decade has been driven by credit expansion, in the context that China’s financial system is dominated by banks. At the same time, she noted that the Net Interest Spread (NIS) has been shrinking.

 

She pointed out that the characteristics of China’s economic structure and macro-economic control give rise to the phenomenon in which the financial industry exhibits ‘counter-cyclical’ growth. She explained that China is capable of effectively implementing counter-cyclical credit policy, which means that it can boost bank credit expansion when the real economy slackens. Developed countries, however, can hardly do so. Therefore, the rise of the financial value-added points to macro-economic control that makes the financial industry to step up support to the real economy. Put differently, the ratio of financial value-added to GDP and the ratio of investment to GDP are the two sides of a coin, she said.

 

Long-term statistics show that when an economy develops to a certain stage, finance’s weight in GDP tends to surge as investment opportunities crop up. Judging from short-term statistics, a rise in financial value-added in a weak economy is not idiosyncratic to China and it is closely related to the ‘risk pricing’ by banks. He Xiaobei referred to the research by Andrew Haldane, former Deputy Governor or Bank of England, which indicated that current calculation method for banking’s value-added is plagued by the inexistence of risk adjustment and treatment. When an economy worsens and banks expect to have a large amount of bad debts in future, they raise credit interest rates (represented by NIS increase) to cover potential asset loss, and the resultant NIS increase is counted as their value-added. In other words, current statistical methods are likely to cause an artificial spike in banks’ value-added; the truth is that the banking industry takes on the risks of the real economy, but the risks are tallied up as banks’ value-added.

 

More importantly, ‘risk’ is a variable that eludes direct observation, leading to non-performing assets being ignored or hidden in statistics, said He Xiaobei. In an extreme scenario, banks might extend a new loan to a failing enterprise so that the latter can pay back a previous loan and interests. This was exactly what happened to Japan in the 1990s: growth in bank credit and value-added was merely a cover for risks of the real economy.

 

Though the Chinese economy has slowed down in growth in recent years, the ratio of banks’ non-performing loans also declined year by year, to 1.6% currently. For He Xiaobei, this doesn’t mean that the assets of Chinese banks are safe since the banks have inevitably taken on a disproportionately large amount of the real economy’s risks. Based on the state of local government debts, credit policy for emerging industries, and policy to prevent spillover of real estate risks, He Xiaobei believed that if economic growth were not robust enough in near to mid-term, the risk of non-performing assets would eventually show up in banks’ balance sheets, leading to capital write-down and a dent in credit expansion and even payment capacity.

 

Despite many factors that have contributed to banks’ relatively low non-performing asset ratio, firm’s debt settling capacity offers a good gauge of latent non-performing asset risks, said He Xiaobei. Since 2017, non-financial listed companies with an Interest Coverage Ratio (ICR) of less than 1 has shot up as a proportion of all non-financial listed firms, reaching 20% in 2022. This indicates a marked increase in the real economy’s debt default risk. Such risky debt has yet to be reflected in banks’ balance sheets. He Xiaobei said that whether China’s banks can withstand the onslaught of large write-down of non-performing assets deserves concerns. For her, a financial industry that cannot set price on risk poses the biggest risk for the macro-economy.

He Xiaobei: Banking Should Brace for Latent Risks

How to make of the phenomenon that China’s financial industry is large in size is of significant value in understanding the role of the industry in the macro-economy as well as the way to set a policy path for realizing ‘a financially robust nation’, wrote He Xiaobei in Lang Run Column, a series of commentaries by NSD researchers. She is Deputy Director of NSD Macro and Green Finance Lab.

 

The value-added of China’s financial industry amounts to around 8% of GDP, close to the levels of the USA and the UK and considerably higher than that of manufacturing powerhouses like Japan and Germany. He Xiaobei’s research showed that the increase of value-added over the last decade has been driven by credit expansion, in the context that China’s financial system is dominated by banks. At the same time, she noted that the Net Interest Spread (NIS) has been shrinking.

 

She pointed out that the characteristics of China’s economic structure and macro-economic control give rise to the phenomenon in which the financial industry exhibits ‘counter-cyclical’ growth. She explained that China is capable of effectively implementing counter-cyclical credit policy, which means that it can boost bank credit expansion when the real economy slackens. Developed countries, however, can hardly do so. Therefore, the rise of the financial value-added points to macro-economic control that makes the financial industry to step up support to the real economy. Put differently, the ratio of financial value-added to GDP and the ratio of investment to GDP are the two sides of a coin, she said.

 

Long-term statistics show that when an economy develops to a certain stage, finance’s weight in GDP tends to surge as investment opportunities crop up. Judging from short-term statistics, a rise in financial value-added in a weak economy is not idiosyncratic to China and it is closely related to the ‘risk pricing’ by banks. He Xiaobei referred to the research by Andrew Haldane, former Deputy Governor or Bank of England, which indicated that current calculation method for banking’s value-added is plagued by the inexistence of risk adjustment and treatment. When an economy worsens and banks expect to have a large amount of bad debts in future, they raise credit interest rates (represented by NIS increase) to cover potential asset loss, and the resultant NIS increase is counted as their value-added. In other words, current statistical methods are likely to cause an artificial spike in banks’ value-added; the truth is that the banking industry takes on the risks of the real economy, but the risks are tallied up as banks’ value-added.

 

More importantly, ‘risk’ is a variable that eludes direct observation, leading to non-performing assets being ignored or hidden in statistics, said He Xiaobei. In an extreme scenario, banks might extend a new loan to a failing enterprise so that the latter can pay back a previous loan and interests. This was exactly what happened to Japan in the 1990s: growth in bank credit and value-added was merely a cover for risks of the real economy.

 

Though the Chinese economy has slowed down in growth in recent years, the ratio of banks’ non-performing loans also declined year by year, to 1.6% currently. For He Xiaobei, this doesn’t mean that the assets of Chinese banks are safe since the banks have inevitably taken on a disproportionately large amount of the real economy’s risks. Based on the state of local government debts, credit policy for emerging industries, and policy to prevent spillover of real estate risks, He Xiaobei believed that if economic growth were not robust enough in near to mid-term, the risk of non-performing assets would eventually show up in banks’ balance sheets, leading to capital write-down and a dent in credit expansion and even payment capacity.

 

Despite many factors that have contributed to banks’ relatively low non-performing asset ratio, firm’s debt settling capacity offers a good gauge of latent non-performing asset risks, said He Xiaobei. Since 2017, non-financial listed companies with an Interest Coverage Ratio (ICR) of less than 1 has shot up as a proportion of all non-financial listed firms, reaching 20% in 2022. This indicates a marked increase in the real economy’s debt default risk. Such risky debt has yet to be reflected in banks’ balance sheets. He Xiaobei said that whether China’s banks can withstand the onslaught of large write-down of non-performing assets deserves concerns. For her, a financial industry that cannot set price on risk poses the biggest risk for the macro-economy.