According to banking and industry sources, growing concerns regarding the mid-to-long term viability of inflated industries in China have triggered a move by many banks to cut lending in various sectors by up to 20 percent. Several developments surrounding changes to China banking have caused traders on Wall Street to view the report with credibility, and Thursday U.S. equity markets took a severe beating, with the S&P 500 seeing its worst drop since February 3.
The Dow Jones Industrial Average fell 231 points, or 1.4 percent, to 16109, the S&P 500 declined 21.9 points, or 1.2 percent, to 1846 and the Nasdaq Composite dipped 62.9 points, or 1.5 percent, to 4260.
Lending credibility to the sources, the China Banking and Regulatory Commission (CBRC) called on banks to submit their regular report of outstanding loans owed by various over-inflated sectors, but has also asked them to include loans linked to derivative products and debt financing.
The request for these two areas — derivative products and debt financing — is a “new development”, said one banking source. Concerns over derivatives and debt financing reek of financial crisis, a timely development following the publishing of a study on PeoplesPunditDaily.com addressing cause of lending-induced financial crisis. When countries’ governments direct lending, then the statistical risk of financial crisis drastically increases.
The request, which is in truth a a demand, comes in the wake of a landmark corporate bond default by Chaori Solar, as well as the default of a coal-related high-yield trust product. These underscore the regulator’s concerns about financial risks posed by heavily indebted sectors, such as steel makers and shipbuilders.
Regardless of whether or not investors’ concerns are warranted in, at least, the short-term, is irrelevant. In the short-term, the risk to investors can be self-created and very real.
“It’s as if traders think some big defaults (in China) are imminent,” said Michael Block, chief strategist at Rhino Trading Partners. “(Chinese Premier) Li spoke out overnight about not allowing systemic risk, which should have been taken well except now everyone waiting for the big default shoe to drop.”
The VIX, which is widely viewed as Wall Street’s fear gauge, shot up by 12.1 percent, while the yield on the 10-year U.S. Treasury bond fell 0.07 percentage point to 2.656 percent, with traders looking for a safe-haven asset. The S&P is down 0.1 percent for the year, while the Dow is down 2.8 percent.
Beijing has attempted to crack down on industrial sectors with surplus production capacity for much of the past 10 years, but they have not been successful.
Chinese industrial production climbed at a lower-than-expected 8.6 percent rate in January through February, and disappointing retail sales have increased concerns about whether the pace at growth in the world’s second-biggest economy will sharply slow down in the near-term.
“The drop-off in industrial production growth, fixed asset investment, retail sales and electricity production confirmed to our economists’ the weakening of China’s economic momentum, while the relatively modest slowing in property investment growth … bolstered their belief that the property sector poses the single largest risk to China’s outlook,” analysts at Nomura wrote to clients.
China industrial industry leaders are now feeling the pressure as the government tries to restructure the economy. It has always been the policy of Beijing to bank on investment — no pun intended — and exports, in order to fuel what has been double-digit growth. However, the communist-led government is trying to shift towards an economy that is more reliant on consumption and services, such as the United States.
China’s cabinet, the State Council, has said that credit must be cut to these sectors and that no new project approvals are allowed until 2017.
The CBRC has not set any targets for a reduction in lending, but banks started to cut loans to struggling sectors late last year, banking sources said.
Some steel mills received letters from their banks this month telling them that their 2014 credit limit would be 20 percent below the amount they borrowed in 2013, industry sources said.