Chinas overall leverage ratio is not exceptionally high compared with other countries, particularly considering the countrys high savings and its bank-centric financial intermediation system.
The pace of increase in the overall leverage ratio in the post-crisis period is a source of concern, but the increase in leverage is disproportionally concentrated in the public sector, while the private sector has been crowded out a key reason for the countrys lukewarm economic performance amid an ongoing build-up in leverage.
Poor transparency on local government finances is a major hurdle affecting confidence in the countrys banking system. However, overall indebtedness of the public sector is well within the countrys fiscal affordability. It is hardly conceivable that the Chinese authorities will let banks shoulder material losses from local government borrowings. In other words, the risk of systemic stress in the banking sector or financial crisis is low.
The build-up in leverage has limited the authorities ability and willingness to boost growth through monetary policy. However, the case for an immediate and violent deleveraging cycle is absent. Policymakers will likely take measures to prevent further rapid increases in leverage and impose regulatory scrutiny over shadow banking activity rather than implement a broad crackdown on credit.
Despite the stellar performance indicators of Chinese banks, the stock market has priced in a material deterioration in banking sector assets. Given banks currently high provision coverage ratio and the countrys fiscal strength, we believe that market concerns over the banking sector are overblown.
This underpins our positive stance on the Chinese equity market.