(Bloomberg) — Just as China’s long bull run for bonds is fading, the nation’s banks have loaded up on government debt at the fastest pace since 2019.
In each of the past two months, commercial banks such as China Construction Bank Corp. raised their overall holdings by more than 20% year-over-year, reaching 72 trillion yuan ($10 trillion) by August, according to central bank data.
It comes at a risky time as the nation’s bond market is about to wipe out this year’s advance. That will add to woes for banks that are already struggling with a growing pile of bad loans and record low margins, as well as threaten the government’s ability to push through more stimulus to boost the economy.
“Banks had to increase bond investments, even though the recent selloff due to booming stocks and a lack of monetary easing was a pain,” said Liao Zhiming, an analyst at Huayuan Securities Co. A lack of demand for loans means they can’t rely on that to generate profits as they used to, but now the emerging source of profits has also come under pressure, he said.
Commercial banks hold about 70% of government debt in the interbank market, ChinaBond data showed. That demand, to some extent, ensures that China can effectively carry out a proactive fiscal policy and keep financing costs low.
Saddled by stagnant or even falling earnings after being enlisted by the government to backstop the economy with cheap loans, the nation’s biggest lenders have been counting on investment income.
That source made up about 20% of the combined second-quarter profit at the state banks, according to GF Securities Co. At China Construction Bank, investment income accounted for almost 27% of total earnings in the second quarter, compared with 4.6% three months ago.
The rising share makes banks more vulnerable to market volatility. While there have been similar episodes in history when lenders loaded up on securities, they were in past cushioned by higher interest rates and wider margins.
Back in 2016, bond yields and net interest margins were at levels twice as high as they are today. A market slide starting late-2016 due to a combination of China’s deleveraging efforts, accelerated inflation and global bond rout left banks largely unfazed.
This year, with the 10-year government bond yield below 1.7%, even for buy-and-hold investors such as banks the coupon protection wouldn’t be able to cover a yield increase of 5 basis points over a quarter, said Huayuan Securities’ Liao. That leaves banks facing shrinking profits or even losses, he said, adding that bonds look more attractive after the recent yield increase.
Regulators have also expressed concerns. A central bank official warned in July that financial institutions with aggressive bond portfolios should be vigilant about interest rate risks and credit risks.
The banks are now seeing limits to taking on more bonds because of pressure from interest rate risk indicator assessments, analysts led by Tan Yiming from Tianfeng Securities Co. wrote in a note. There will be greater demand to sell old bonds to realize profits in the fourth quarter, they said.
–With assistance from Helen Sun.
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