Which Chinese Bank Has The Tallest Floodgates?

The author is Michael Werner, senior research analyst covering the Chinese and Hong Kong banks at Sanford Bernstein & Co.

Recent Spikes in SHIBOR (Shanghai Interbank Offered Rate) Rates have raised awareness regarding liquidity risk in China. While we still believe credit risk is the main threat to the Chinese banks, their liquidity risk is rising, highlighted by the spikes in short-term SHIBOR rates recorded in mid- and late-2013.

Prior to that, many Chinese banks relied on the "PBoC put," which is the assumption that the Chinese central bank would never allow a liquidity crunch to occur.

In general, liquidity risk contagion caused by market panic is often more difficult to predict and measure than credit risk. In a worst case scenario, a widespread collapse in market confidence could manifest itself in sudden liquidity dry-ups, producing an equally disastrous impact than a credit event.

Liquidity positions at the Chinese banks weakened in recent years. Nowadays, not only has it become more difficult for banks to gather deposits, as non-bank investment products such as trust products and money market funds, increase competition with the banks’ traditional deposit base, borrowings from China’s interbank market also become more costly.

Since the SHIBOR spike in June 2013, interbank interest rates have been volatile and at elevated levels. Despite the changes in funding structures, banks are holding fewer cash/cash equivalents and highly liquid securities on their balance sheets.

The China Banking Regulatory Commission finalized liquidity management rules last month, urging banks to shore up their liquidity coverage ratio to over 100% and their liquidity ratio to over 25%. It also reinforced the 75% loan-to-deposit cap.

However, these regulatory guidelines only provide a summarized view of a bank’s liquidity position; we believe there are other metrics that investors should examine for a more detailed analysis.

We have analyzed the banks’ liquidity profiles on both the asset side and the liability side. On the liability side, we examine which of the banks’ funding bases are most stable thus lowering their rollover risk.

On the asset side, we measure the ability of banks to generate funds without incurring too much loss in a difficult environment, as well as maturity mismatch not only from the perspective of its interbank book but also that of the whole balance sheet.

Across the banks we cover, we found large banks’ liquidity profile is stronger than smaller banks’ as their reliance on customer deposits, as a cheap and sticky source of funding, and lower dependence on interbank borrowings is a clear competitive advantage.

Minsheng Bank is the worst positioned among all the banks we cover as it is ranked in the bottom 3 in 7 out of 9 key metrics we examined. This reinforces our bearish view on Minsheng’s fundamentals.

We believe lack of access to high-quality funding will continue to constrain Minsheng’s ability of expanding its balance sheet and compress its net interest margin.

China Merchant Bank also scored low as its window dressing behaviors are the most obvious. This highlights the bank’s difficulty collecting deposits and its deteriorating retail banking franchise.

While we believe a liquidity event such as a bank run is unlikely in China, we do believe risk for such an event has increased over the past 12 months.

(The article has been edited for clarity)

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