I wrote in April and June about the Chinese slowdown. I thought that it would get worse but the Chinese economy fooled me again. The last time I made a dire prediction about the Chinese economy was in December of 2008. Why did I make these mistakes? I underestimated the Chinese government’s taste for risk.
I was wrong. I wrote in April and June about the Chinese slowdown. I thought that it would get worse but the Chinese economy fooled me again. It rebounded. Real estate prices rose. Retail sales increased. Both service and industrial production expanded. I say again, because the last time I made a dire prediction about the Chinese economy was in December of 2008. Why did I make these mistakes? The simple reason is that I underestimated the Chinese government’s tastes for risk.
Law gets in the way of the Chinese communist party. So they usually do quite well without it. But certain types of laws, those dealing with insolvency can be quite handy in clearing debts to encourage the creative destruction of capitalism. It is this destruction that governments around the world have taken enormous risks to avoid.
When the Chinese economy contracted rapidly in 2008, the government responded by allowing its banks to double and even triple the number of loans they made in prior years. One problem with this strategy was that they had not successfully dealt with the bad loans from the recession in 1999 to 2000. Yet neither the banks nor the government were that concerned. Chinese banks made 80% from the ‘spread’, the difference between the money they paid depositors and the amount they charged in interest. Since both were set by the government, the banks were guaranteed to make money. Bad debts were basically passed on to the depositors as a hidden tax. So without fear of the consequences, the Chinese economy sailed its way through the recession on a tide of debt, while the rest of the world’s financial system was stuck in insolvent mud.
You can stimulate your economy this way, but too much money eventually pushes up prices. In China this means real estate. Real estate makes up 15% of the Chinese GDP (gross domestic product); provides local governments with most of their income and is considered the only reliable investments. Incomes have increased in China, but real estate prices have grown up to four times faster. With the dream of a home outpacing most family income, the government became concerned with social unrest, to say nothing of millions of unoccupied apartments and a potential real estate bubble. So they solved the problem. In an economy driven by the state, the state slows the economy, not with market forces like interest rates, but with new rules and regulations.
The rules and regulations worked, but a bit too well. The real estate market slowed and along with it the Chinese economy. Growth in China fell from over 9% in late 2010 to 7.4% today. The slowdown was exacerbated by the recession in China’s major export market in Europe and marginal growth in the US. There are also other factors. Firms are relocating to cheaper locations and FDI (foreign direct investment) has slowed. The slowdown was a particular embarrassment in 2012 when China had its once-in-a-decade change of leadership. This is supposed to be a celebration of the Communist Party’s accomplishments and not evidence of failure.
Fortunately a new source of funding has appeared. As any Wall Street banker knows, rules exist to be circumvented. Chinese financial institutions are no different. They created trusts. These off balance sheet vehicles make or amalgamate loans and sell them to investors as wealth management products (WMP). In theory this system was illegal or at least a grey area. But it suited the banks which were looking for more profit and the local governments that were looking for more ways to borrow money. It also suited investors and depositors who were looking for safe ways to get a decent return on their money. Most recently it has suited the government who wanted to stimulate the slowing economy.
These products were wildly popular. They now have 12 trillion yuan ($1.9 trillion) under management—almost 13% of the banking system. They have grown over five times since 2009. They have provided the financing for the recent real estate recovery and the money for ambitious infrastructure projects along with continued heavy lending from the state banks. But there is one problem. These products can default.
Recently there have been issues with products issued by Huarong Financial, Huaxia Bank and even China’s largest financial institutions—China Construction Bank and CITIC. These products are until next year issued off the balance sheet of the issuing institution. They are unregulated with little or no transparency. Many go to very speculative projects, specifically real estate development whose land purchases support local governments. There is also a dangerous asymmetry. The products usually are issued for a few months, but the loans can be for years.
Two of these problems are especially interesting because they illustrate how these problems are resolved. Huang Financial is especially interesting because Huarong was originally set up as one of the AMCs, companies set up by the four major banks to get rid of the bad debts from the 1999 to 2000 recession. Not only did they fail to resolve the debts they never paid back the $250 billion bonds that they owed the banks, the bonds matured and were rolled over. Instead the AMCs like Huarong morphed into lending financial companies.
Huarong lent money to LDK Solar. When the loan went bad, LDK was bailed out by the Xinyu city government. Having a government entity pick up a company’s debt happened in the US as well. The problem is that like the US, the governments are already saddled with heavy debts from the last round of stimulus.
A similar problem occurred with Shandong Helon a rayon manufacturer in the city of Weifang. Helon has long been in trouble, not for its main business, but for real estate speculation. It borrowed $63 million in the form of commercial paper which it could not repay. In stepped the city of Weifang, a 16% owned of the company, and repaid the creditors of the commercial paper to avoid the major embarrassment of the imminent default. But the price was to stop payment to Helon’s other creditors like the large Chinese banks. This is not an isolated incident. Helon is a state-owned company and according to the World Bank, a quarter of them do not make any money. Despite the lack of profits they have almost exclusive access to loans from the state owned banks.
Both the PBOC (People’s Bank of China) and the CBRC (China Bank Regulatory Commission) have finally expressed concerns. The PBOC’s latest announcement speaks of “controlling risks” and the CRBC has asked for a list of all WMPs. But both have a major problem. If they draw too much attention to the bad products they may start a panic. Investors have been assured that these products are perfectly safe. Also if they shut down the industry they also stop the flow of money that is helping stimulate an increasingly inefficient economy. If the economy slows again, the problems will increase. So like the US regulators before them in the sub-prime crisis, their interest may be too little too late.
(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages.)
Public sector banks, like SBI, PNB, BoB and Canara Bank should review their exposure to non-core operations like insurance ventures to conserve capital and promote banking operations, feels the Finance Ministry
New Delhi: The Finance Ministry has asked public sector banks to review their exposure to non-core operations like insurance ventures to conserve capital and promote banking operations, reports PTI.
"We also want banks to look at their non-core area operation. Some of the banks have gone into non-core areas," a senior Finance Ministry official said.
"They (banks) should look at non-core area investment when big global banks are exiting from their non-core areas and conserving capital," he said.
Many banks, including State Bank of India, Punjab National Bank, Bank of Baroda and Canara Bank, have many joint ventures in non-core business like life insurance, non-life insurance, mutual funds, etc.
This assumes significance as government is in the process of infusing Rs12,000 crore into about 12 public sector banks to enhance their capital base.
At the same, there is huge requirement of capital to meet Basel III, the global capital norms for banks. The global norms scheduled to kick in from 1st January this year has been deferred by another three month.
RBI, however, did not provide reasons behind the rescheduling.
RBI had issued guidelines on the implementation of Basel III capital regulation in India in May last year. These guidelines were to be implemented from 1 January 2013 in a phased manner and were to be fully implemented by March 2018.
As per the new global norms, banks will have to hold core capital of at least 7% of risk weighted assets by 2018.
Last year, RBI Governor D Subbarao had said Indian banks will require an additional capital of Rs 5 lakh crore to meet the new global banking norms, Basel III.
Of the total Rs5 lakh crore, equity capital will be Rs1.75 lakh crore, while Rs3.25 lakh crore will have to come as the non-equity portion.
The government, which owns 70% of the banking system, alone will have to pump in Rs 90,000 crore equity to retain its shareholding in the public sector banks at the current level to meet the norms.
Reserve Bank may release its final guidelines for new bank licenses by January-end or early next month
New Delhi/Mumbai: The Reserve Bank of India (RBI) is likely to issue final guidelines for grant of banking licences to new players within the next four-six weeks, while those interested in setting up new banks, including giants like Reliance, Religare and L&T groups, have begun doing the groundwork, reports PTI.
According to sources in Finance Ministry, the Reserve Bank may release its final guidelines for new bank licenses by January-end or early next month.
The Finance Ministry is currently in the process of sending its final comments to the RBI on the draft guidelines issued by the central bank on the matter, after which the final guidelines should be announced.
The RBI is already in the process of collating the comments received from various stakeholders on the draft guidelines.
RBI Deputy Governor Anand Sinha, who is incharge of the Department of Banking Operations and Development at the central bank, is scheduled to retire next month and RBI should finalise the norms before his retirement, sources said.
A number of large corporate houses, including Anil Ambani-led Reliance Group, financial conglomerates Religare and Shriram groups, engineering-to-technology major L&T group and Aditya Birla group, are said to be interested in entering the banking business depending on the regulatory framework.
Industry sources said that most of the banking aspirants have begun doing their groundwork and quite a few large corporate houses are confident of meeting the regulatory framework despite some voices being raised in certain quarters about concerns of possible conflict of interest in case of industrial houses being given banking permits.
Last week itself, noted economist and Nobel laureate Joseph Stiglitz said corporates should not be allowed to enter banking space as it has the potential to create conflict of interests.
However, experts back in India dismiss the concerns and say that bank licenses should be given to those who can safeguard the interest of consumers and ensure liquidity, irrespective of them being a corporate house or anything else.
"Bank licence should be given to promoters with strong track record and credence irrespective of being a corporate house or an NBFC, as depositors interest is paramount. RBI has guidelines in place which is best across the globe and is testified by the fact that very few banks have failed in the country," said eminent Chartered Accountant S Ravi, who is on board of various public companies.
Noted economist and former Secretary General of apex industry body FICCI, Rajiv Kumar, also said a strong regulatory framework can take care of the conflict of interest issue.
"As long as there is high quality regulation, the apparent conflict between corporate interest and banking interest can be resolved and, I think, if corporates willing to get into banking sector can create a firewall between their corporate interest and financial interest it should be fine," he said. .
After delivering a lecture organised by the Reserve Bank of India in Mumbai last week, Stiglitz said the real problem in the financial sector were issues of conflict of interests.
"And when you have corporates opening their own banks, you are opening a venue for conflict of interests," he said.
SMC Capitals' Equity Head Jagannadham Thunuguntla said even the draft guidelines and discussion papers have enough safeguards.
"I believe RBI is one of the best regulator in the world. So in that sense corporates getting a licence is fine. Earlier Kotak had got banking license and they did well. So there is no problem with corporates getting into banking," he said.
Stiglitz also praised the RBI for doing a commendable job in its management of banking regulations and said the need of the hour is not over-regulation but right regulation.
He, however, said the argument of bringing 'economies of scale' by giving licences to corporates did not hold water as the "dangers of conflict of interest outweigh any economies of scale that it can bring up."
Drawing parallel between the debate in the western world regarding the conflict of interest with respect to separation of investment banking and pure banking operations, he said that a Chinese wall can not be created between the two.
Rajiv Kumar said the "criteria for eligibility should be a good track record and some minimum networth that they have and their some demonstrative ability to run a financial institution."
"So if they have done something in the insurance sector or the NBFC sector etc then they should be given a preference," he said.
In a major step to reform India's banking sector, the Lok Sabha last month passed the Banking Laws (Amendment) Bill, 2011, paving the way for establishment of new private banks among other measures.
The RBI had issued draft guidelines in August 2011 for issuance of new banking licences, while in July 2012 it released the comments and suggestions received by it. However, it wanted the government to amend the banking laws before starting the process towards issuance of new banking licences.
Among the major groups interested in seeking new banking licenses, Religare Enterprises' chief Shachindra Nath said, "It is important that new banks are brought in to contribute towards the overall financial inclusion and development agenda."
Nath said Religare was waiting for RBI to come out with its final guidelines post which it would evaluate how to align its banking business model with the regulatory intent.
Another banking aspirant L&T Finance's President and Wholetime Director N Sivaraman as also said that his company has a vision of being a comprehensive financial services provider and the banking license has a potential to enable it provide all products and services. .
"Currently we are a lender with some other services, but with deposits and other banking services, we shall get to interact with all customers on all grounds and would wait for the final guidelines of RBI," Sivaraman said.
Reliance group is another entity to have shown its interest in starting new banks ever since a proposal was floated about two years ago to issue new licences.
Addressing the shareholders of the group's financial services arm Reliance Capital in 2011, Anil Ambani had went on to say that the group's banking entity could be called 'Reliance Bank' depending on the regulatory framework.
Reliance Capital CEO Sam Ghosh also recently said the group is full-prepared from its side for banking foray and it has been working on this for quite some time.