Global Banks Are Staging A Bank Run In China

| About: iShares China (FXI)

By Valentin Schmid

The more debt the merrier, the saying goes, at least until the party stops and the hangover starts. This is true for the debt situation inside China, as well as for international lending to China.

According to the Bank for International Settlements (BIS), total cross-border bank lending to China decreased $63 billion to $698 billion at the end of the first quarter of 2016. Over the year, this measure is down 27 percent.

"Since hitting its all-time high at the end of September 2014, cross-border bank credit to China has contracted by a cumulative $367 billion (-33 percent), with interbank and inter-office activity leading the decline," the BIS writes in a recent report.

The total stock of outstanding cross-border bank credit was $27.5 trillion at the end of March 2016.

This is important because that money is not coming back. Once the loan or debt is paid off, it vanishes and can't be used to fuel other financial or economic transactions. It is part of the reason why many economies in the world are teetering on the edge of a recession, with only bank lending to Western governments balancing out the emerging market credit decline.

The reduction in bank lending is part of the capital that is flowing out of China by the hundreds of billions - $676 billion in 2015 alone.

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International Institute of Finance (IIF)

Banks in Hong Kong decreased their China exposure by 4.5 percentage points from 32.8 percent of assets at the end of 2014 to 27.3 percent at the end of 2015, according to rating agency Fitch, the first decrease in a decade.

International banks are wary of a slowing Chinese economy and a rise in corporate defaults.

According to rating agency Standard and Poor's (S&P), China's credit quality is "deteriorating more quickly than at any time since 2009," it states in a recent report. S&P downgraded three companies for every company upgraded in the first half of 2016.

Chinese corporates will "come under increasing strain as economic growth slows, industrial overcapacity crimps profitability and cash flow, and an elevated appetite for expansion weakens leverage."

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Claims of international banks of different countries in U.S. dollar trillion (left) and U.S. dollar billion (right) (Bank for International Settlements (BIS))

And international banks don't want to wait for that to happen. Neither do they want to wait for a sharp devaluation of the Chinese currency.

"A sharp depreciation of the yuan, which would be the consequence if the [foreign currency] reserves would have to be used to safeguard systematically important entities that do have foreign currency debt. This would be the consequence of a failure to act, a recession and, in the worst case, a financial crisis. Again, something that's survivable; not the end of the world, but very costly and politically destabilizing," said Citigroup chief economist Willem Buiter.

Hugh Hendry, principal at the hedge fund Eclectica, is more pessimistic. "Tomorrow we wake up and China has devalued 20 percent, the world is over. The world is over. The euro breaks up. Everything hits a wall. There's no euro in that scenario. The U.S. economy, I mean everything hits a wall," he told RealVisionTV earlier this year.