China Economics Seminar

During a recent seminar, we heatedly discussed the following news from the Global Times:

Compared with the end of August, the top four state-owned Chinese banks, including the Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of China and China Construction Bank, saw total deposit outflows of about 420 billion yuan ($65.63 billion) during the first 15 days of September, according to a report by China Securities Journal on Thursday.

What we really care about is one question behind the news: where did the RMB 420bn in deposits flow to?

First, the deposits might have flown into the shadow banking system from the formal banking system. One answer quickly came to mind: wealth management products. It’s no secret that banks have been widely using these products to stay within the regulated maximum loan-to-deposit ratio of 75%, especially since China Banking Regulatory Commission (CBRC)’s monthly checking early this year. The usual practice is that the banks issue short-term, high-yield wealth management products financing long-term investments, and overcome the maturity mismatch by rolling these products over. The most creative part of this arrangement is that they often mature at the end of month. They then immediately turn to deposits that stay on the banks’ balance sheets over month end, lowering the loan-to-deposit ratio temporarily. Actually, the top four state-owned banks issued 20% more wealth management products in August, under pressure to increase reserves for margin deposits. Therefore, the RMB 420bn decrease in deposits may be partly due to enlarged scale of wealth management products.

There was another part of shadow banking system that the RMB 420bn may rest on, that is, the hyperactive private lending market. A 24% annualized rate of return can be quite compelling for households that face negative real interest rates in traditional deposits. Wenzhou, for example, had evolved a private lending market of RMB 110bn in July, which was 20% of total bank loans, according to the Wenzhou branch of the PBoC.

The outflow of banking deposits into the above two destinations has gone on for quite some time. And these two parts may have accelerated recently. However, could there be a catalyst for deposits outflow? Or—let’s think more boldly—could the deposits have flown out of  China's financial system altogether?

We believe it’s possible that foreign capital has been starting to flow out to seek safe haven instead of flowing in. We saw a drastic emerging market sell-off at the peak of the 2008 crisis; now, under the dark cloud of the European debt crisis and a potential global recession, foreign investors are likely to do the same thing. Although currently we don’t have mainland market data to confirm, there was an indication of this possible outflow in Hong Kong market, which is deeply integrated with the mainland. The Hong Kong RMB, known as CNH, traded as wide as 2.5% discount to onshore CNY, and the spread closed at 12bps on Friday, Sept. 23. For a long time, the spread was very small as a result of arbitrage activities, and CNH often had a little premium over CNY due to its liquidity and appreciation expectation. The unusual divergence, combined with recent RMB depreciation, suggested a large-scale sell-off of RMB denominated assets. This flight from RMB to the dollar was so tremendous that Bank of China (HK) announced on Friday afternoon that its 4 billion quarterly conversion limit had been hit.

No matter where the 420bn deposits actually went, we have good reason to worry about the outflow. If they turned into wealth management products or private lending, we would be more concerned about a possible shadow banking crisis. If instead they had been converted to dollars and escaped from China market, the outcome would be more than critical for China economy.

Central Banking Seminar