Why China’s Banks Need a New Source of Funding

China’s banks are looking to less reliable debt markets as deposit growth is drying up

By Anjani Trivedi

When the river starts running dry, start looking for water elsewhere.

That’s what China’s largest banks have done lately. With their traditional funding base of deposits slowing to a crawl, they have raised more than $70 billion in debt markets so far this year. That’s the most since at least 1995 over the same period; and already 40% of last year’s record issuance, according to Dealogic.

With deposit growth slowing faster than loan growth, Chinese banks’ loan-to-deposit ratios, a measure of their reliance on borrowed funds, have started to inch up. The door was opened to this when China scrapped a 75% cap on loan-to-deposit ratios last year. Across China’s largest banks, this ratio rose to 72% at end of last year, from 69% the year before.

To make up for slowing deposits, China’s financial institutions are turning to market-based funding, which also means greater swings in costs. Especially, as yields in China’s interbank bond market have spiked in recent weeks and international capital markets remain volatile.

Funding from deposits costs approximately 1%, while that from the onshore interbank bond market is closer to 2.5% and international capital markets is more like 3%. The trouble is all this hits banks’ net interest margins further, already shrinking under the pressure of lower interest rates and rising credit costs.

Looking for new funding sources may prove to be a painful adjustment for China’s banks. Already, there are signs that investors are less willing to fund China’s banks than they once were. Last week, for instance, investors pulled cash off the table because policy lender China Development Bank’s bonds didn’t compensate them enough.

Capital markets aside, there are other maneuvers to keep funding intact. Banks could start locking in deposits for longer to secure funding while lending out shorter-term loans to deal with deteriorating asset quality. That too however, would erode their net interest margins.

All this of course, only takes into consideration what’s actually on banks’ balance sheets. With net-interest margins shrinking, banks of late have been significant issuers of off-balance sheet investment-linked wealth management products, in which short-term funds are raised from consumers and invested in bonds, stocks and other assets. The funding risks here are arguably even more acute.

With banks getting their funding from less secure sources, it will serve China’s banks to know the worth of wáter.

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