China banks are playing a risky game: the deposit shuffle. The rules are simple. Pile billions of yuan in customer deposits onto the balance sheet in time for the financial reports, then shimmy them off right afterward.
The motivation for this “window-dressing” is simple – to make it look like the banks’ loans do not exceed the regulatory limit of 75 per cent of deposits. The regulatory cap on the interest rate banks can pay on deposits makes funding cheap but hard to find, so the banks are tempted to game the system.
At Bank of China, one of the more conservative of the big four state-owned lenders, the average of deposits reported in December and June was 6 per cent higher than the daily average deposit base for the six months, which it reports separately. In the previous six months, the gap was 4 per cent, the same as at Minsheng in the most recent period.
Some of the extra deposits come from so-called wealth management products, which are basically relatively high-yield term deposits with a non-bank financial institution, often sold through a bank. Fitch estimates there are 10.4 trillion yuan of these products in issuance. Many are timed to pay out at the quarter end, turning into deposits just when the banks need them most. That can then shift into new products days later.
The obverse of the gap between daily average and period-end deposits is a gap in loans to “other financial institutions,” a category that includes issuers of wealth management products. They need cash to pay out holders at maturity, so it may not be surprising that at Bank of China, the start-and-end average in this item was 10 per cent higher than the daily average, or that Bank of Communications, an active seller of wealth management products, doubled its exposure to other financial institutions between September and March.
Is there anything to worry about? Well, these pseudo-deposits are a less stable source of funding than the real thing. Small banks, which are generally weaker, seem to be particularly reliant on them.
Even more concerning is the desire and ability of banks to get ahead of their regulators. In itself, window-dressing is not that dangerous, but a financial crisis is much more likely when banks decide that regulation is more of an obstacle than a help.