By Raunak Bhiwal
Last Sunday, the Bureau of International Standards(BIS) published its quarterly report which identified China as one of the economies at the risk of a major banking crisis. Canada and Hong Kong are the two other countries whose banking system are the most vulnerable. The report covered the method to identify early signs of a crisis using the Credit-to-GDP gap. In China, the gap is currently at the level where it could possibly lead to the failure of the entire system.
What is a Credit-to-GDP gap?
Losses to the banking sector can be colossal when preceded by a period of excessive lending, that is, when it leads to the formation of a credit bubble. Failure of the banks in such cases creates a domino effect, where, if the recession is large enough, the entire global banking system may collapse, like it could have during the 2008 crisis. To preempt such a disaster from happening, Basel III has mandated banks to build up Countercyclical Buffer to help them fend off a similar crisis.
Credit to GDP ratio is the ratio of countrys national debt to its total GDP. Research has shown that the credit-to-GDP ratio has worked well as the indicator of an impending bank crisis. A bigger number indicates that the debt is growing at a rate, faster than the term growth.
As per Basel norms, if the ratio exceeds a 2% mark, then the country should raise their countercyclical buffer. Anything above 10 is highly risky. However, Chinas Credit-to-GDP has constantly remained above 10, with only slight improvements in the recent times. Canada and Hong Kong may also be heading towards a higher ratio, partly due to climbing property prices. Hong Kong property prices are amongst the highest in the world, and the property related lending in Hong Kong stands at 45% of the total lending. However, BIS has clarified that even though the gap indicates the distressed situation of the banking system of the three countries, it does not guarantee a banking crisis. A spokesperson for the Hong Kong Monetary Authority made a statement to CNBC saying,Hong Kong’s banking sector remains healthy and well capitalized, and has the ability to weather through stresses.
Problems with the Chinese banking system
BIS is not the first international body which has flagged the concern. IMF has also identified three major tensions in Chinas financial system that could unhinge the worlds manufacturing hub. The first one is their high Debt-to-GDP ratio, which stood at 255% at the end of second quarter in 2017. The second one is the rise of ‘Shadow Banking’ and the third one is ‘moral hazard and excessive risk-taking’ which emanates from the mindset that the government will bail out the troubled banks. Although, China has strengthened its regulatory oversight; a slowdown in the economy and their ageing population will put a lot of pressure on its bank to ease monetary policies to create liquidity.
Impact of these results on India
The banking and finance system is the support function of any economy. It keeps the companies in the economy up and running. From working capital to long-term loan requirements, the companies turn to banks. A failure of the banking system in China will massacre the whole economy. It will have far-reaching implication across the globe and the impact will be both direct and indirect, especially for India.
A direct impact will be experienced because the trade figures between India and China are currently at an all-time high of $84 billion. Indias automobile, telecom, and pharmaceutical sector are highly dependent on the Chinese market. If the banking sector in China falls, then the Indian capital goods and manufacturing sectors will be heavily impacted. India exports diamonds and cotton to China, which will also take a massive hit if the demand weakens due to a banking system failure in China.
The indirect impact would be felt due to the intricate connection between all the economies of the world. If China sneezes, the whole world likely catches a cold. A simple example will beChina is the biggest lender of the US. It holds $6.26 trillion of US treasuries. In a case where China loses its capacity to lend money, the US wont be able to finance its ever-increasing debt. Also, the US imports heavily from China. The cost of running the business will rise in the US if there is any hindrance in the Chinese economy. Similarly, Australia and Brazil export their ore to China making their economies heavily dependent on China. In this way, almost all economies are connected to China is some way or the other.
With a slew of measures coming from the government, India is more open to the world then it was back in 2008. India, itself has to handle its banking system along with its financials. Any global hiccup created by China, while India is still under a major process of development, will have major implications for the Indian economy. During the 2008 recession, Indias growth was sub -5%. One can only imagine the drop in the growth level of India if China experiences a failure in the current economic scenario.