Chinese Bank Margins have fallen to an all-time low

Chinese Bank Margins have fallen to an all-time low 🚨 pic.twitter.com/rcvvtj8MPJ

— Barchart (@Barchart) September 16, 2024

Chinese banks are the major buyers of China’s local government debt. They often purchase and underwrite bonds issued by local government financing vehicles (LGFVs), which are used to fund infrastructure projects. This involvement is part of broader efforts to manage and mitigate local debt risks, especially given the significant financial challenges faced by many municipalities.

China’s local government debt problems are a hidden drag on economic growth

The development has caused an uproar online and damaged already fragile business confidence. Since June 2023, the CKGSB Business Conditions Index, a monthly survey of Chinese businesses, has hovered around the 50 level that indicates contraction or expansion. The index fell to 48.6 in August.

Major policy changes are tough, especially in China’s rigid state-dominated system.

Underlying the investment-led focus is a complex interconnection of local government-affiliated business entities that have taken on significant levels of debt to fund public infrastructure projects — which often bear limited financial returns.

Known as local government financing vehicles, the sector is a “bigger grey rhino than real estate,” at least for banks, Alicia Garcia-Herrero, chief economist for Asia-Pacific at Natixis, said during a webinar last week. “Grey rhino” is a metaphor for high-likelihood and high-impact risks that are being overlooked.

Natixis’ research showed that Chinese banks are more exposed to local government financial vehicle loans than those of real estate developers and mortgages.

“Nobody knows if there is an effective way that can solve this issue quickly,” S&P’s Li said of the LGFV problems.

“What the government’s trying to do is to buy time to solve the most imminent liquidity challenges so that they can still maintain overall stability of the financial system,” she said. “But at the same time the central and local government[s], they don’t have sufficient resources to solve the problem at once.”