China Banks' Negative Cashflow - The Squeeze Intensifies

China's banking numbers,  released on Friday, were genuinely nasty, though not necessarily for the reasons mostly cited (a slight slowdown in monthly loan growth, which, on closer inspection still turned out to be  higher than you'd expect in July). Rather, the problem is deposits, which fell by 670b yuan, or 0.9% MoM, at a time when you'd normally expect deposits to rise about 0.6%. In fact, even before you take seasonal patterns into account, this was still the worst month for deposits since October 07. Probably part of  this retreat is simply a reaction to June's mad dash for deposits to satisfy quarterly and semi-annual inspections by CBRC centred on LDRs. Nonetheless, over the three months to July, the sequential growth of deposits was 1.3 standard deviations below historic trends. 

By itself, that would be a worry. But the funding squeeze on China's banks is far worse than merely that,  because there have been six hikes in reserve ratio requirements this year, with big banks now having to hand over 21.5% of their deposit base. Once you factor in those RR hikes, you'll find that whilst deposits are growing at 15.4% YoY, growth of deposits potentially available for lending or purchase of other assets has now fallen to 8.5% YoY. And this is the slowest rate since - well, my database starts in 1998, and it can show me no similar slowdowns. 

But yuan loans are still growing at a rate of 15.0%, and even though the loan/deposit ratio of China's banking system prints at 66%, that's still means China's banks are now giving out loans far faster than they are taking in deposits available to be lent. 

Over the 12 months to July China's banks took in 10.4 trillion yuan in new deposits, and made 6.76 trillion in new yuan loans - a positive cashflow of 3.64 trillion yuan. However, at the same time, the state commandeered 5.614 trillion yuan of those new deposits. So when you subtract those, the banks' net cashflow situation looks very different - after reserve ratios, the banks made just under 2 trillion yuan more new loans than they took in new and available deposits. In other words to keep lending at this rate, banks need to sell other assets, or take on new liabilities (such as foreign equity or bonds).  They need to do that simply to recreate a cashflow which has been confiscated by the state.

PBOC used this tactic of -  shall we call it redacting the inflow of deposits? - back in 2003/04 and again in 2007/08. But what's happened since September 2010 has been bigger, and sharper, than has ever been seen before in China. 

In 2003/04, the cashflow squeeze peaked in May 04, and for six months after that sequential loan-growth collapsed to 2 SDs below seasonalized trends, with the result that by May 05, loan growth had slowed to single digits (9.2%). 

In 2007/08, the cashflow sqeeze had a double nadir in Oct 07 and Jan 08. Although the subsequent slowdown in loan-growth was not as dramatic as in 2003/04 the subsequent collapse of the domestic economy is a matter of record.  

So even in July 2011 proves to be the absolute nadir of the squeeze, unless we see a concerted relaxation of regulatory and policy pressure, the 16% loan growth target is likely to be missed by a long way this year. My best guess at the moment? Unless something changes. . . . 11%.