Now, this could really be a canary coming out into the sunlight and ready to sing!
China Banking Situation [10/11/2011]
A day after the Shanghai index reached a one year low, Central Huijin Investment, a holding company that is part of China’s sovereign wealth fund, came in and bought shares of the four largest Chinese banks. The valuation of the Chinese banks had fallen to the 2008 financial crisis levels due to concerns of bad debt that these banks were holding. Last night the Shanghai Composite index only gained 0.2 percent because Chinese energy companies, China Shenhua Energy Co and Yanzhou Coal Mining Co, dropped more than 4 percent - offsetting the financial sector gains.
The Shanghai index had fallen 16 percent this year as the Chinese government imposed policies to fight inflation. Higher interest rates and an increase in reserve requirement ratio for banks were to blame for the slump in the stock market.
The bad debt problems in China can be very alarming and can potentially bring down the Chinese economy. These bad debts were/are repackaged and transferred to the Asset Companies to be sold to the public. At the same time, the banks are backing these products. It is important to keep in mind that the biggest shareholder of these banks is the Chinese government. This recent purchase is nothing more than a shareholders recapitalization. If these bad debts do become a runaway crisis, it will set off a domino effect in the Chinese economy where the public will be holding these repackaged toxic assets and the banks must meet their obligations on them and ultimately, if unable to meet those obligations, the Chinese government will have to step in to save the banking system. The chain of events will throw China into economic turmoil. [source]
By Carrie Ho and Ruby LianPosted 2011/11/10 at 8:47 pm EST
SHANGHAI, Nov. 10, 2011 (Reuters) — Sitting in China's copper and steel warehouses is a hidden risk to the world's second-largest economy -- banks' indirect exposure to a property market that is showing signs of stress.
Many lent that cash in informal markets, earning as much as 70 percent interest -- a nice return given that bank fees and commissions on letters of credit (LC) can be as low as 3 percent for established companies, and allow payment some six months down the line.
With a chunk of their loans business in lockdown after Beijing clamped down on lending, especially for the property sector, banks found such trade financing an attractive alternative as it had not fallen under the central bank's ever-tightening restrictions.
While Beijing has moved to clamp down on the practice, banks are still exposed to an unexpected batch of bad loans should a slump in property prices and sales coincide with another sharp fall in commodity prices.
"Banks are already heavily exposed to the property sector and if a chunk of their trade finance books is also exposed to real estate, they could be in for a double whammy," said Stanley Li, China banking analyst at Mirae Assets.
"The end-game may be very nasty if higher financing costs, a property price correction and a slump in commodity prices trigger waves of defaults," said Li, who has researched extensively into the risk of this cash-for-commodity phenomenon in China.
ESCAPED COMMODITIES ROUT UNSCATHED
Banks will already be breathing a sigh of relief that they have made it through one potential crisis.
A brutal commodity rout in September, which saw London copper prices down by more than a third at one point to a 14-month low and Shanghai steel prices down 20 percent, sparked warnings that some firms would be unable to meet margin calls on their LCs and force banks to auction off commodities held as collateral.
"Prices did fall below our covenant so we had to get clients to top up margins or increase inventories. But we haven't had people who can't pay up," said a senior executive at a foreign bank that focuses on loans to the commodities business.
The pricing formulae for copper, which allow buyers to set prices after the cargo arrives, as well as the extensive use of hedging instruments, have helped blunt some of the price gyrations.
Prices for Shanghai copper futures fell by 20 percent in September, to as low as 51,580 yuan a tonne.
"Prices didn't fall enough for defaults to happen and the decline was also quickly arrested. If it (copper) had fallen to around 40,000 yuan a tonne, a lot of small trading firms might not have made it," said an executive at a trading firm.
PROPERTY PRICES FALLING
However, there are still plenty of such loans outstanding to smaller trading firms in copper and steel, exposing banks and traders to the risk that the once-frothy property market could start to see a serious correction.
The property market, once a favorite of speculators, is now starting to see prices fall and, with them, revenues for those who had invested in developments, impacting the ability of some investors to repay their loans.
Some housing projects in Shanghai have already lowered prices by around 30 percent in recent weeks and some developers have run into problems repaying their debt, according to local media reports.
Though it will try to keep the market steady, Beijing risks holding on too long to its tightening policies aimed at reining in home prices and inflation even as it faces slowing economic growth and strong external headwinds.
Should the traders who have borrowed through trade finance start to lose money on their property deals or not be repaid what they lent to others to speculate on property, that could potentially be a catalyst for a chain reaction of defaults, analysts say.
"You'll need a convergence of a few events to unleash this can of worms: a sustained, sharp fall in copper or steel prices that coincides with a large amount of these trade-related loans maturing," said the loans executive from the foreign bank.
SOME FIRMS GOING BUST
There is no reliable data on the extent of such trade financing -- inventories of commodities can be anything from poorly catalogued to a state secret -- but what is sure is that it is widespread enough that it has expanded beyond copper into the markets for steel and soybeans.
With steel prices still in the doldrums and a significant portion of the country's 610 million tonnes of "rebar" inventories used as collateral, it is now the weakest link in this elaborate scheme.
For steel, which is largely domestically traded, merchants tend to either use their warehouse stocks as collateral for loans, or to turn to acceptance bills, an equivalent to a letter of credit for domestic markets... finish reading at source: NewsDaily
