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Economist-Insights 1 July

Economist-Insights 1 July

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Published by buyanalystlondon
Economist-Insights 1 July
Economist-Insights 1 July

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Published by: buyanalystlondon on Jul 02, 2013
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Economist Insights
 Minsky momentum
1 July 2013Asset managementMost people knew very little about the interbank marketbefore the 2008 financial crisis. Back then, even those thatdid know about it paid little attention to the rates thatbanks charge each other for short-term loans when theyhave mismatches in their funding. Once Lehman collapsed,it became clear to investors that problems in the interbankmarket could create problems throughout the whole economy.When interbank lending rates jumped in China last week itraised alarm bells: could this be the start of China’s own crisis?Not necessarily. As with so much else in China, the state wasbehind the move. The People’s Bank of China (PBoC) hadapparently tired of the way that some of the banks wereusing balance sheet chicanery to circumvent the rules, whilerelying on the PBoC to support them in the interbank market.When the PBoC refused to support the market, many bankswere caught out and demand for interbank loans out-strippedsupply, pushing interest rates to record highs. The scale of thereaction may have been higher than intended but the messagefrom the PBoC was clear: banks must bring their lending undercontrol.This is likely to be a common message over the coming monthsand quarters. It is easy to imagine that the incoming leadershiplooked at the state of the credit market and thought, “lookat the potential mess that we have just inherited”. Total socialfinancing, which is a wide measure of lending but still missesout a lot of ‘shadow banking’, has been growing far morerapidly than the economy since 2008 (chart 1). Much of thisrecent lending has taken the form of non-standard lending,mostly trust loans (chart 2) that often feed into wealth-management products (WMPs). These WMPs are raising a lotof concern amongst analysts who remember how the US gotinto trouble in the run-up to 2008.The details of the WMPs are varied and can be quite complex(which is a concern in itself) but the key point is that banksare packaging together off-balance sheet loans and sellingthem to private households as a high yield investment but onethat lacks the guarantee of a bank deposit. The potential formis-selling is high, and the potential for surprise losses if loansdo not perform is high. Given the huge surge in lending tolocal governments for pretty much any infrastructure project atpreferential rates in recent years, it is hard to imagine that non-performing loans will not rise even faster than they already are.
Joshua McCallum
Senior Fixed Income EconomistUBS Global Asset Management joshua.mccallum@ubs.com
Gianluca Moretti
Fixed Income EconomistUBS Global Asset Managementgianluca.moretti@ubs.com
Chart 1: Minsky’s shadow
Cumulative increase in total social financing and nominal GDPsince 2002, CNY trillions
Source: People’s Bank of China, National Statistics Bureau China
Interbank lending rates in China jumped last week, as thePeople’s Bank of China decided to withdraw its support in theinterbank market. The aim was to send a message to China’sbanks to bring their shadow lending under control. Totalsocial financing has been growing far more rapidly than theeconomy since 2008. The rapid rise in lending fits the classicpath towards a Minsky moment (stability leading to under-pricing of risk, leading to misallocation and then a crisis). Giventhe momentum on this path, the recent spike in interbanklending rates could be a good thing by reminding the marketthat there are risks and reminding banks that the rules arethere for a reason.
020406080100Nominal GDP
Total social financing

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