Western Bank Exposure to Mainland China Explodes Higher – Australia Vulnerable

We recently cited the work of Sean Darby, equity strategist at Jefferies, regarding the exposure of Hong Kong banks to the Mainland (see: “How Dangerous is China's Credit Bubble for the World” for details). Although Hong Kong is technically part of China, it is a foreign country in terms of its economic system and currency, and should therefore be regarded as a foreign creditor. In fact, the incentives that mainly influence the business decisions of Hong Kong's banks include the US Federal Reserve's monetary policy as a very important factor, due to the fact that the Hong Kong dollar is pegged to the US dollar via a currency board.

Mr. Darby has in the meantime continued to dig into topic of foreign bank exposure to the Mainland, and has recently released his latest findings. Here is a Bloomberg chart that shows how these claims have grown since 2005:



China ClaimsForeign participation in China's credit boom: note the involvement of French and Australian banks specifically – click to enlarge.



The numbers are as follows at present (the percentage change is since Q1 2011, indicated by the vertical line on the chart above).


Country % change Total in US$ 3Q13
Germany      +66% 32bn
France  +60% 41bn
UK   +70%  193bn
Total Europe  +70%  329bn
Australia   +230% 31bn
US +18%    83bn


The total exposure of Western banks thus amounts to $709 billion. Australia's banks were a bit late to the game, but sure did their best to catch up quickly, as the 230% increase in their claims since 2011 shows.

In other words, we now have additional evidence of the growing vulnerability of Australia specifically. As we already pointed out in our musings about how “financial contagion” might spread from China in spite of its closed capital account, Australia is a pivotal region. Australia's economy greatly depends on China's commodity imports, and its banks have financed an enormous real estate bubble on the back of the commodities boom.

Moreover, Australia's banking system itself is highly dependent on foreign short term funding sources. Although the chart above doesn't tell us anything about the maturities of the claims on China, we would not be surprised if many or even most of the loans to China had much longer maturities than the foreign funding Australian banks get from (mainly) Europe. The main point is though that we have yet another source of potential trouble for Australia here – the exposure of Australian banks to China amounts to 9% of Australia's GDP at this point.


Lured by High Spreads, Interesting Times Await

As Mr. Darby points out, the amounts have grown quite large in absolute terms. Banks have evidently been lured by the higher spreads they can earn on loans to Chinese customers, and in large part this is due to the ZIRP policies pursued by major Western central banks. However, higher spreads usually obviously imply higher risk. Adding Hong Kong's exposure to the above numbers, we arrive at about $860 billion in total foreign exposure (ex-Japan we might add).

In the course of this year, some $800bn. of debt issued by 'wealth management products' is coming due in China, and Mr. Darby notes in this context that the potential knock-on effects on Western banks from an increase in non-performing loans in China are probably not properly appreciated at this juncture.

Especially UK banks with a huge $193 bn. in total exposure, as well as Hong Kong banks (approximately $150 bn. in net claims) and Australia's 'big four' banks seem to be in the line of fire here.

Moreover, we must expect that in the event of a shadow banking crisis in China – a highly probable event given what is known about the practices of the sector and the amount of debt coming due in the near future – will have considerable effects on numerous emerging market economies, especially if China should eventually decide to devalue the yuan (currently the yuan seems quite overvalued actually). In that event, both commodity exporters and exporters of semi-finished and final goods that compete with China would feel the pinch.

This would in turn mean that Western banks would not only have to grapple with a possible rise of NPLs in China itself, but also with an even bigger currency and debt crisis in a number of emerging markets. Since many Western banks remain in weak condition following the 2008 crisis and the euro area debt crisis, they will then be inclined to further reduce their lending in their home countries as well, so as to preserve capital. A vicious cycle could easily be triggered.

It is quite ironic in this context that German sentiment data provider Sentix recently noted that 'bullish sentiment on bank stocks has reached a record high'.



20140120_sector_sentiment_jan_englSentix sentiment indicator on European bank stocks storms to a record bullish consensus in late January – click to enlarge.




There is a very good chance that the crisis that began in 2008 is actually not over by any stretch – it is merely moving from one place to the next. After all, the developments discussed above are a direct result of the reaction of the world's monetary authorities to the initial crisis. China's credit bubble and ZIRP in the US and Europe are all children of the crisis and have evidently sown the seeds for the next crisis. As we always stress, we expect that the next major crisis will eventually lead to a crisis of confidence in said monetary authorities. At some point, faith in central banks is bound to crumble and then we will really experience 'interesting times'.



Charts by: Bloomberg, Sentix




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10 Responses to “Western Banks and China: ‘Interesting Times’ Are Coming”

  • phil coleman:


    As an Australian I read this with some concern. I think there is an error where you state that Australian banks are exposed to China to the tune of 9% of GDP. As the exposure is about US$31B and our GDP is about AU$1.5T the exposure to China is actually about 2%. Overall the exposure to Asia (Japan, Singapore, Hong Kong, India, Korea, etc.) is about AU$132B which is not far off the 9% figure you quoted. This doesn’t make it any the less of a worry though.

    A factor that you don’t mention is that the four big Australian banks make up 30% of the market capitalisation of the ASX200. That’s right; just four companies have a total market cap of about AU$390B and comprise about 30% of the top 200 companies. And since the total market cap is about the same as the GDP at AU$1.5T these four companies comprise about 26% of the total value of all stocks in the country! Add to that two other disturbing facts: One is that these banks are exposed to a massive local real estate bubble and another is that these banks borrowed foreign money to finance this bubble at a time when the local currency was strong but the $AUD is now tottering. You therefore have the setting for a perfect financial storm.

    These are the reasons why I don’t have any bank shares. I am hoping to avoid the “interesting times” that you alluded to. Thanks for your regular informative and interesting articles and for your constant and entertaining presentation of the ideas of the Austrian school of thought. You are an inspiration.

  • Hans:

    Tenebrarum, means brilliant in German…

  • I agree with that Mark Humphrey. I have been trying to find someone to write about the western exposure to China. I wonder what kind of hot money through hedge funds is tied up in this mess? Doug Noland had an article in the Bulletin this week that said that China banks had extended as much credit in the past 5 years as there were assets in the US banks. It appears to be a bomb of epic proportions about to go off.

    • Crysangle:

      When we consider what the relatively (capitals) accountable west is able to get away with in its convergence to a state capitalist system , and will continue to do so as long as society allows it, even if that society recedes into a shadow of its former ability , then maybe we might guess at how much scope the regime in China actually has, with it being a far greater monopoly of power . The figures of Chinese debt expansion crossed with US asset values is not clear as there is no free exchange rate – the whole monetary show is within Chinas’ boundaries , the Yuan could be only worth a tenth … or be worth ten times … its set price . PT tackled the reserve status , the likes of Argentina have grown ‘restless’ partly because of their shallow reserves and hence the perceived ability of the nation to procure ‘wealth’ (i.e. material goods) from abroad. Personally what I wonder is exactly what ‘project’ is being installed/redirected in China , if that is sustainable or adaptable to the populations expectations and demands , to the economy’s ability, to resource parameters , or if we will see a lot of upset Chinese who feel they have been ripped off. So exactly how the state steps into the shadow banking world (and I expect it will try to take it over) is maybe what bears watching too .

  • No6:

    Agreed, except I believe this is the best blog out there by far.

  • SavvyGuy:

    > There is a very good chance that the crisis that began in 2008 is actually not over by any stretch…

    I agree. My gut feeling is that the 2008 crisis was a Wave 1 down in Elliott Wave terms, and the current “recovery” is a Wave 2 up. Wave 3 down might indeed turn out to be a “wonder to behold”!

    • roger:

      The problem with this interpretation is that wave 2 has already exceeded wave 1 in nominal terms. This is not allowed per EW rules. Maybe if you use inflation-adjusted charts it is still feasible but I’m not sure of the merits of this.

      • SavvyGuy:

        EW rules were developed when the monetary unit was neither stretchable nor “concoctable” by fiat. Therefore, EW rules can obviously never apply to today’s funny-money nominal values. Real values must be somehow derived and then respected!

  • Mark Humphrey:

    I am always impressed by the extent and depth of your knowlege of various markets and developments around the world. This is one of the top blogs I have ever come across. It’s very helpful to me. Many thanks for your work.

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