The recent tightening of credit we have seen in China is primarily aimed at clamping down
on shadow financing. Wealth management products have rapidly grown in size, from only
8% of total banking deposits in 2012 to over 20% today. The top chart shows China’s banks’
claims on non-banks, which is where a lot of shadow financing shows up. As we can see,
growth in this category has fallen precipitously from 70% YoY to 20% today.

However, there is collateral damage from this tightening. For one, bank-lending rates are
starting to rise as their cost of funding rises (bottom-left chart). Policymakers in China want
to confine the rise in rates to the interbank market, but this is a next-to-impossible task. Too
great a rise in lending rates would feed negatively into the real economy. Moreover, as the
bottom-right chart shows, tightening has led to broad credit-growth falling to near to 0% on
a 3-month basis. A negative second derivative in credit must be watched for any inhibitive
effects it may have on economic growth – especially in a country so heavily credit-dependent
such as China. A negative first derivative in credit, as we are on the cusp of today, leaves
economic growth even more fragile. Investors should watch the situation closely. (Click on image to enlarge.)

Source: Bloomberg, Macrobond and Variant Perception