Chinese Banks Face Growing Challenge with Lending

SHENZHEN, CHINA - NOVEMBER 16: A boy sits outside a branch of the Bank of China while using a smartphone on November 16, 2024 in Shenzhen, Guangdong Province, China.

Cheng Xin | Getty Images News | Getty Images

Chinese commercial banks are currently facing a significant dilemma.

As consumers and businesses remain pessimistic about the future of the world's second-largest economy, the growth in loans has stagnated. Recent stimulus measures introduced by Beijing have not successfully stimulated consumer borrowing or ignited a robust recovery in the struggling economy.

So where are banks putting their excess cash? They are turning to government bonds.

Since December, Chinese sovereign bonds have enjoyed a strong rally, with 10-year yields plunging to historic lows this month, falling approximately 34 basis points, based on data from LSEG.

Edmund Goh, an investment director at abrdn in Singapore, commented, "The lack of strong consumer and business loan demand has directed capital inflows into the sovereign bonds market." He also pointed out that a critical issue for banks onshore is the scarcity of investment opportunities, especially as there are no indications that China will soon escape deflation.

According to data from the People's Bank of China, total new yuan loans issued in the eleven months leading up to November 2024 dropped over 20% to 17.1 trillion yuan ($2.33 trillion) compared to the previous year. In November, new bank lending was reported at just 580 billion yuan, a significant reduction from 1.09 trillion yuan one year prior.

This lack of loan demand persists, despite extensive stimulus initiatives that began rolling out last September when the economy was at risk of not achieving its full-year growth target of around 5%.

Goldman Sachs forecasts that growth in the Chinese economy will slow to 4.5% this year, with expectations that credit demand will continue to weaken in December compared to November.

According to Lynn Song, chief economist at ING, "There is still a lack of quality borrowing demand, as private companies are hesitant to approve new investments, and households are tightening their spending."

This year, authorities have committed to prioritizing the enhancement of consumption and to encourage credit demand by reducing the costs of corporate and household borrowing.

Due to the prevailing uncertainty, investors are likely to continue seeking "risk-free yield sources" this year, given the potential for tariff actions from other countries, as Song noted, with lingering doubts regarding the strength of domestic policy support.

No Better Alternatives

The downturn in loan issuance comes at a time when mortgages, once a significant driver of credit demand, are still experiencing a bottoming phase, according to Andy Maynard, managing director and head of equities at China Renaissance.

Onshore investors in China are facing a shortage of opportunities in both financial and physical markets where they can invest their money, he observed.

Recent data showed that China's annual inflation for 2024 was only 0.2%, indicating minimal growth in prices, while wholesale prices have fallen by 2.2%.

There is a growing optimism surrounding government bonds as institutions believe that economic fundamentals will remain weak, coupled with decreasing expectations for an aggressive policy response, according to Zong Ke, a portfolio manager at the Shanghai-based asset manager Wequant.

Ke remarked that the present policy interventions are aimed mainly at preventing economic collapse and cushioning against external shocks, merely functioning to avert a drastic downturn.

The Perfect Storm

Meanwhile, the yield on U.S. 10-year Treasuries has been increasing rapidly since June, with a recent spike pushing the yield above 4.7%, close to levels not seen since April.

The widening yield gap between Chinese and U.S. government bonds poses a risk of capital outflows and could further pressure an already weakening yuan.

Recently, the onshore yuan hit a 16-month low against the dollar, and the offshore yuan has been on a prolonged decline since September.

Sam Radwan, founder of Enhance International, described the situation as a "perfect storm," highlighting the low government bond yields, the prolonged real estate crisis, and the threat of rising tariffs as concerning factors that weigh on foreign investor sentiment towards onshore assets.

Despite the diminished appeal of Chinese bonds to foreign investors, the difference in yields with U.S. Treasuries has not significantly impacted the performance of Chinese government bonds, as foreign funds hold a relatively small portion, said Winson Phoon, head of fixed income research at Maybank Investment Banking Group.

Silver Lining

Falling yields could, however, present a silver lining for Beijing by reducing funding costs, with expectations that policymakers will increase new bond issuance this year, as highlighted by ING's Song.

In November, Beijing announced a $1.4 trillion debt swap initiative aimed at alleviating the local government financing crisis.

For much of 2024, officials acted to intervene whenever the 10-year yields approached 2%, but it was noted that the People's Bank of China had quietly ceased its interventions by December.

Market participants now anticipate that the central bank will introduce additional monetary easing measures this year, including further cuts to key interest rates and reductions in reserve requirements for banks. The People's Bank of China indicated at the beginning of the year that it intended to lower key interest rates at an "appropriate time."

Yet, expectations of rate cuts may only sustain the ongoing bond rally.

Economists at Standard Chartered Bank predict that the bond rally will persist this year, albeit at a more moderate pace, with a projected decline in the 10-year yield to 1.40% by the end of 2025.

They forecast that credit growth could stabilize by mid-year as stimulus measures begin to have an effect on specific sectors of the economy, leading to a reduced decline in bond yields.

Recently, the central bank announced it would temporarily halt its purchases of government bonds due to excess demand and limited supply in the market.

China, Lending, Bonds