Monday, February 11, 2013

Sanderson and Forsythe, China’s Superbank

China’s Superbank: Debt, Oil and Influence—How China Development Bank Is Rewriting the Rules of Finance (Wiley/Bloomberg, 2013) by Henry Sanderson and Michael Forsythe, both Bloomberg reporters working in Beijing, is a fascinating book. Those of us who learn about the Chinese economy only through the standard media outlets have very little idea of how it is being fueled. This book follows the money trail, from the China Development Bank to local Chinese municipalities and to the far corners of the globe (if, that is, the globe actually had corners). The task is daunting since “CDB’s assets and lending are a large black hole in global finance. Few other banks have been as unwilling to answer questions from the public….” (p. 178)

CDB, an arm of the state, is financed almost exclusively by bond sales rather than deposits. “It sells bonds to commercial banks, which use people’s savings to buy the bonds and earn higher yields for absolutely zero risk on their balance sheets. To this day, the banking regulator has allowed these commercial banks, among the largest in the world, to assign a zero-risk weighting on the bonds, meaning they have to set no capital against them, even as CDB has ramped up lending to a host of commercial sectors and risky countries with long histories of defaults, such as Venezuela and Ecuador. The bonds are, in effect, sovereign bonds, but the state takes no overt responsibility for the lending. For the commercial banks they are free returns. The yields on CDB bonds have been for the most part higher than the benchmark deposit rate but lower than the lending rate—that is, the commercial banks can earn a return buying risk-free CDB bonds with depositors’ money rather than lending the money out and taking the risk of default.” (p. 69)

International banks that buy CDB bonds also believe that the state will stand behind them, so CDB bonds aren’t rated. Or, to be more precise, when CDB bonds sell overseas, the rating agencies rate them at the same level as sovereign bonds.

An underlying assumption of CDB’s lending to local infrastructure projects is that land prices will increase as a result of the projects. Local governments uproot farmers from their plots, give them little by way of compensation, and use this land (often at wildly inflated prices) as collateral for their loans and bond offerings. The town of Loudi is a case in point. There, according to a 2011 bond prospectus, eighteen tracts of land valued at $1.5 million an acre were used as collateral. “That’s the price recently offered for an acre of land adjoining a private golf course on Indian Hill Road in Winnetka, Illinois, one of the wealthiest towns anywhere in the world. Average family income in Winnetka: $250,000 a year. In Loudi, average yearly take-home pay is $2,323. And yet the bond was rated AA by Beijing-based Dagong Global Credit Rating Co., one level higher than the same company rated US sovereign debt in 2012. The company that gave the land appraisal was in the same office as the city government’s land bureau. ‘The income from selling land is a reliable guarantee for the timely payment of interest on this bond,’ the bond’s prospectus said.” (p. 16)

CDB backs a wide swath of Chinese government interests. For instance, in 2010 it lent $14.7 billion to clean energy and other energy-saving projects, about seven times the sum that the U.S. Federal Financing Bank lent that year. It actively pursues loans-for-energy deals. It has a private equity subsidiary that makes domestic yuan investments, a securities company that was the top corporate bond underwriter in China in 2012, and a leasing subsidiary.

Is this behemoth and its development model sustainable? That’s the XXXX-trillion-dollar question. China’s Superbank offers readers the necessary background to begin to formulate hypotheses.

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