China’s next debt crisis will be a local affair
By John Foley
(The author is a Reuters Breakingviews columnist. The opinions expressed are his own)
China’s next credit crisis may be a local affair. A recent suggestion of setting up local bailout funds reflects the fact that it’s no longer big banks that present the biggest risks, but towns and regions. The elaborate ties between local borrowers, lenders and governments could make future credit problems both chaotic – and concentrated.
China’s credit growth has been moving away from big national banks in recent years. While large lenders account for over half of total loans, only 37 percent of total credit growth in 2012 came from bank credit. An equal amount, for example, came from “entrusted” loans, where companies lend to other companies – often suppliers or customers with local links.
Local lending can involve multiple players. City-level banks and smaller rural co-operatives often bring in “guarantee companies” – of which China has over 8,000 licensed to back loans. Others settle for less formal assurances. Wenzhou, a city famous for its entrepreneurs, emerged as a hotbed of cross-company guarantees and high-rate loans in 2011.
Governments themselves rely on local funding, too. Just under $1.5 trillion of local government loans were outstanding at the end of 2012, according to the chief bank regulator. While national banks have taken their share, the quality of loans may diminish with the size of the lender. Officials can too easily bully local banks by threatening to take official deposits elsewhere.
The result is that the if one lender in a region fails, others are likely to follow. Local governments have gone out of their way to avoid corporate bond defaults, most likely for fear they may be cut off from the market, too. In December, the local government stepped in after a rural credit co-operative in the manufacturing heartland of Jiangsu found itself unable to pay back savers.
An idea of setting up local bailout funds, first floated by the Ministry of Finance and bank regulator a year ago, is a step in the right direction. Regional governments have a better chance of understanding the linkages between companies and credit providers. But they would need to act quickly: if loans go bad, a lack of confidence won’t stay local for long.