Author Pater Tenebrarum, Acting Man
We recently cited the work of Sean Darby, equity strategist at Jefferies, regarding the exposure of Hong Kong banks to the Mainland (see: “How Dangerous is China’s Credit Bubble for the World” for details). Although Hong Kong is technically part of China, it is a foreign country in terms of its economic system and currency, and should therefore be regarded as a foreign creditor. In fact, the incentives that mainly influence the business decisions of Hong Kong’s banks include the US Federal Reserve’s monetary policy as a very important factor, due to the fact that the Hong Kong dollar is pegged to the US dollar via a currency board.
Mr. Darby has in the meantime continued to dig into topic of foreign bank exposure to the Mainland, and has recently released his latest findings. Here is a Bloomberg chart that shows how these claims have grown since 2005:
Foreign participation in China’s credit boom: note the involvement of French and Australian banks specifically – click to enlarge.
The numbers are as follows at present (the percentage change is since Q1 2011, indicated by the vertical line on the chart above).
|Country||% change||Total in US$ 3Q13|
The total exposure of Western banks thus amounts to $709 billion. Australia’s banks were a bit late to the game, but sure did their best to catch up quickly, as the 230% increase in their claims since 2011 shows.
In other words, we now have additional evidence of the growing vulnerability of Australia specifically. As we already pointed out in our musings about how “financial contagion” might spread from China in spite of its closed capital account, Australia is a pivotal region. Australia’s economy greatly depends on China’s commodity imports, and its banks have financed an enormous real estate bubble on the back of the commodities boom.
Moreover, Australia’s banking system itself is highly dependent on foreign short term funding sources. Although the chart above doesn’t tell us anything about the maturities of the claims on China, we would not be surprised if many or even most of the loans to China had much longer maturities than the foreign funding Australian banks get from (mainly) Europe. The main point is though that we have yet another source of potential trouble for Australia here – the exposure of Australian banks to China amounts to 9% of Australia’s GDP at this point.
Lured by High Spreads, Interesting Times Await
As Mr. Darby points out, the amounts have grown quite large in absolute terms. Banks have evidently been lured by the higher spreads they can earn on loans to Chinese customers, and in large part this is due to the ZIRP policies pursued by major Western central banks. However, higher spreads usually obviously imply higher risk. Adding Hong Kong’s exposure to the above numbers, we arrive at about $860 billion in total foreign exposure (ex-Japan we might add).
In the course of this year, some $800bn. of debt issued by ‘wealth management products’ is coming due in China, and Mr. Darby notes in this context that the potential knock-on effects on Western banks from an increase in non-performing loans in China are probably not properly appreciated at this juncture.
Especially UK banks with a huge $193 bn. in total exposure, as well as Hong Kong banks (approximately $150 bn. in net claims) and Australia’s ‘big four’ banks seem to be in the line of fire here.
Moreover, we must expect that in the event of a shadow banking crisis in China – a highly probable event given what is known about the practices of the sector and the amount of debt coming due in the near future – will have considerable effects on numerous emerging market economies, especially if China should eventually decide to devalue the yuan (currently the yuan seems quite overvalued actually). In that event, both commodity exporters and exporters of semi-finished and final goods that compete with China would feel the pinch.
This would in turn mean that Western banks would not only have to grapple with a possible rise of NPLs in China itself, but also with an even bigger currency and debt crisis in a number of emerging markets. Since many Western banks remain in weak condition following the 2008 crisis and the euro area debt crisis, they will then be inclined to further reduce their lending in their home countries as well, so as to preserve capital. A vicious cycle could easily be triggered.
It is quite ironic in this context that German sentiment data provider Sentix recently noted that ‘bullish sentiment on bank stocks has reached a record high‘.
There is a very good chance that the crisis that began in 2008 is actually not over by any stretch – it is merely moving from one place to the next. After all, the developments discussed above are a direct result of the reaction of the world’s monetary authorities to the initial crisis. China’s credit bubble and ZIRP in the US and Europe are all children of the crisis and have evidently sown the seeds for the next crisis. As we always stress, we expect that the next major crisis will eventually lead to a crisis of confidence in said monetary authorities. At some point, faith in central banks is bound to crumble and then we will really experience ‘interesting times’.