CHINESE regulators are scrutinising regional banks’ bond investments amid concern that they are speculating on the securities rather than lending to boost the economy, according to people familiar with the matter.
Policymakers this week requested information from rural lenders including their bond-trading activities over the past three years, their major counterparties and the necessity of the investments, the people said, asking not to be named discussing private matters.
The regulators have asked banks to explain how they’ll focus on their key business of supporting small companies, the people added.
Regulators are tightening oversight on bond investments after a heated rally sent longer-term sovereign yields to near a record low earlier this week. While lower yields allow the government to enjoy cheaper funding from the debt market, authorities may be worried that the frenzy will make lenders reluctant to allocate more funds to loans crucial for supporting the economy. A market reversal might also expose banks to capital-eroding losses.
The People’s Bank of China didn’t immediately respond to a request for comment.
“Given the lack of long-dated assets and very sticky liability costs, the tendency is for banks to extend duration to get higher yields and positive carry,” said Becky Liu, head of China macro strategy at Standard Chartered. The PBOC would want more funds to flow into the real economy, and also reduce speculative trading out of concern over smaller banks’ ability to manage risks, she added.
Credit expansion has been weak despite efforts by authorities to boost liquidity through cuts to the reserve requirement ratio for banks and cash injections via other tools. A measure of domestic loan growth expanded by 10.4 per cent year-on-year in January, a record low.
Chinese bonds have been on a tear this year as an uncertain economic outlook bolstered bets that the central bank will further ease monetary policy. While the rally took a breather on Thursday (Mar 7), disappointment over a lack of stimulus measures unveiled at the National People’s Congress will likely keep demand strong.
Worrying signs of a bubble have started to emerge. The 10-year yield trades below the benchmark one-year policy rate, an indication that traders may have gotten ahead of themselves in pricing in potential rate cuts. The yield advanced two basis points on Thursday to 2.29 per cent, set to snap a three-day fall.
“The step should be a part of authorities’ efforts to stabilise credit, but the impact on credit supply will be very limited given the small scale of those rural banks,” said Serena Zhou, senior economist at Mizuho Securities.
While it’s unclear how much bonds the regional lenders hold, their bets can backfire if the market direction reverses. SVB Financial Group offers a cautionary tale. The US lender had pumped billions of dollars into longer-term Treasuries on expectations that rates would remain steady – only to see its massive wager fall apart as the Federal Reserve embarked on its steepest rate-hike cycle in decades.
China has a vast network of around 3,800 rural lenders, including commercial banks and cooperatives. Their assets totalled 54.6 trillion yuan (S$10.13 trillion) – or 13 per cent of the entire banking system – as of end-2023, according to official data.
While the rural system plays a crucial role in underdeveloped areas, many have long struggled with weak profits, soured assets and lax governance. The group has been operating in a more difficult environment since 2019, when China’s push for more loans toward small businesses triggered a price war with bigger peers.
“At current levels, risk reward does not justify chasing yields lower,” said Frances Cheung, strategist at Oversea-Chinese Banking Corp. “The authorities probably see the risk that smaller investors enter the market in this late leg of the bond rally and hence carry out prudent checks.” BLOOMBERG
