Chinese government's rapid credit expansion to savage the demand slump due to the Great Recession will eventually come back to hunt its large banks, which still pretty much direct their loans under governments' orders (source: WSJ)
That Bank of China is seeking to raise money in both the mainland and Hong Kong markets is a surprise. It had earlier said there would be no need to raise extra cash in Shanghai. But the size of the rights issue—the bank is hoping to raise nearly $9 billion–means both markets are being called upon.
Assuming the issue runs smoothly, by the end of the year Bank of China's balance sheet should be back at a level that will satisfy cautious regulators. Its overall capital-adequacy ratio should be around 12% by end-2010, Goldman Sachs estimates, above Beijing's 11.5% minimum requirement.
But this small degree of clearance has broader significance. Bank of China hopes to keep its capital adequacy at around 12% for the next three years without any more calls on investors.
The implication is that it expects a much slower rate of loan expansion over the medium term, certainly than it has experienced since the end of 2008. Bank of China built its loan book faster than China's major banks in 2009, with its loan balance rising nearly 50%, as Chinese banks pumped out around $1.4 trillion of new loans to support economic growth. In that time, its capital-adequacy ratio dropped from 13.43% at the end of 2008 to 11.09% at the end of March this year.
This may not be an immediate problem, as long as Chinese policy makers are intent on taming last year's breakneck rate of credit expansion. But if the global economy dips again, institutions such as Bank of China will have less ability than before to help insulate China from any fallout.
In a crisis, the banking regulator might be prevailed upon to lower its required capital-adequacy levels again. Alternatively, Bank of China might find itself going back on its word about future capital raising.
Either way, what looks like a sure footing today won't be much to count on.
It looks more likely that the US is entering the New Normal, as predicted by PIMCO folks.