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China's Deleveraging Drive Pushes Foreign Bank Loans To Record Heights

Summary

The total exposure of foreign banks to China hit a record high of USD$1.89 trillion in the first half of 2017.

Constrained credit conditions created by Beijing's deleveraging campaign are spurring domestic corporate borrowers to seek capital abroad.

While foreign giants such as HSBC and Standard Chartered are focusing on China as a new growth source, exposure could be risk fraught given its huge debt levels.

Foreign banks are taking advantage of the constrained credit conditions created by Beijing's deleveraging drive to lend record-breaking sums to Chinese borrowers.

The total exposure of foreign banks to China reached USD$1.89 trillion at the end of June, as compared to $1.67 trillion at the start of the year, and ahead of the previous record of $1.84 trillion.

The figures from a new report by Sabine Bauer, senior director for financial institutions at Fitch Ratings in Hong Kong, include flows of cross-border loans into China, as well as most loans provided by foreign-invested bank subsidiaries.

The Chinese central government launched a heavy-handed deleveraging drive at the start of the year, which has seen the People's Bank of China tighten monetary policy and implement stricter macro-prudential regulations, staunching the availability of funds and raising borrowing costs.

As a consequence China's corporate borrowers are searching abroad for cheaper, more accessible funding, driving a surge in offshore bond offerings and bringing a bonanza of opportunity to international lenders.

Cross-border lending into China saw a boom period from 2009 to 2014, when loose monetary policy on the part of the Federal Reserve drove down rates for dollar-denominated debt.

As a consequence loan repayments to overseas banks accounted for much of China's outbound capital flows across 2015.

Overseas borrowing dropped once the Chinese yuan began to depreciate in 2015, raising the cost of repayment for US dollar loans. A 7% rise in the yuan since the start of the year, however has helped to restore the lustre of foreign loans alongside the constrained credit conditions created by deleveraging.

While overseas banks may now reap a profit boost on the back of the higher interest rates for lending to Chinese borrowers, Bauer warns that increased exposure to China is fraught with risk given the surge in its debt levels since the Great Financial Crisis.

"Expansion into China will support Hong Kong banks' margins but could also expose risks," wrote Bauer.

"An increase in China exposure without adequate controls and capital buffers could...be negative for bank's ratings."

Foreign giants such as HSBC and Standard Chartered have made explicit their focus on China as a growth source.

"Our pivot to Asia is driving higher returns and lending growth, particularly in Hong Kong and the Pearl River Delta," said HSBC chief executive Stuart Gulliver in an earnings statement issued last week.