Financial deleveraging only halfway through, may continue to 4Q17 or beyond.
太阳城娱乐网， Financial deleveraging has made progress: banking asset growth has softened; shadow banking and WMP have decreased; and the credit-to-deposit ratio has started to moderate. However, we do not think the process is close to the end, as the government has not fully achieved its deleveraging goal or reached its tolerance level. We expect tightening to continue till 4Q17 or beyond, keeping market rates elevated. While this helps lower systemic risks, the likely near-term impact is slower credit growth, higher shadow banking credit risk and earnings/capital pressure for smaller banks. Thus, we stay neutral on the sector with a clear preference for deposit-funded banks (i.e. the Big Four).
How has the financial deleveraging taken effect.
We have witnessed positive developments. Asset growth in the China banking system has slowed to a 10-year low at 12% yoy as of May 2017 (2016: 16%), as banks cut excessive leverage. In detail, banks have scaled back interbank borrowing and NCDs due to the higher funding cost. This has led to the unwinding of shadow banking credit (in the form of credit to NBFIs) and interbank lending. As a result, the credit-to-deposit ratio has stopped increasing and moderated slightly (Fig 13). Another evidence of deleveraging is a decrease in banks’ WMP balance for the first time after years of strong growth. WMP AUM was Rmb28.4tr as of May-17, down 2% from end-2016.
When will it end? Key is to watch the government’s goal and tolerance level.
We expect financial deleveraging to continue until 4Q17 or beyond. The government has not yet achieved its deleveraging goal. Measured by credit-to-deposit ratio, financial leverage stayed elevated at 115.6% in May 2017 vs. the 81% it should be in theory (i.e. 1 minus reserve ratio). We think the regulator may try to lower the ratio to around 110% by scaling back credit to NBFIs and converging the growth rates of broader credit and deposits. We believe the government will take action if there are bank runs in the wholesale funding market, a significant property price correction or a notable slowdown in GDP growth. These tolerance thresholds are unlikely to be reached in the near term. What will likely happen next is the release of new regulations in the asset management industry and wealth management products.
What to track.
We closely track several indicators to assess the progress of financial deleveraging. Firstly, we track the balance sheet changes of China’s banking sector, where we would need to see a decrease in the credit-to-deposit ratio to around 110%. Secondly, banks’ net claim to NBFIs would need to decline, as it is a good proxy for self-circulating funds within financial sector. Thirdly, we would need to see lower interbank rates with less volatility if financial deleveraging is close to ending. We track DR007, R007, GC001 and NCD rates (Fig 19).
What does it mean for equity investors? Performance divergence to widen.
As we highlight in the earlier reports in the series, I, II and III, the kicking in of financial deleveraging would bring slower credit growth. The asset quality of shadow banking may weaken and smaller banks may face earnings and capital pressure. We see value at big banks but near-term headwinds are possible. For joint-stock banks, we expect further downside as the impact of financial deleveraging has not fully exhibited. Buying ICBC and selling Minsheng.
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