China threatened by widespread bad loans

Borrowing costs at their highest in six months.

The yield spread for one-year AAA bank bonds over similar-maturity sovereign notes jumped 56 basis points so far this month to 163 basis points, the highest in ChinaBond records going back to 2007.

Money market rates reached their highest level last week, forcing the three top rating agencies to warn banks may run out of cash to pay investors in their wealth management products and to extend new loans, increasing the risk their customers will default.

China’s total credit stands close to 200% of gross domestic product, said Fitch Ratings. Analysts expect some deleveraging at banks’ interbank and wealth management businesses to occur. Credit growth is also expected to slow, thereby putting pressure on banks’ asset quality.

Bad loans at banks have increased for six straight quarters through March 31, the longest streak in nine years. Chinese commercial banks’ outstanding non-performing loans rose 20% to US$86 billion at the end of the first quarter from a year earlier, accounting for 0.96% of total lending, said the China Banking Regulatory Commission.

Analysts said these figures don’t reflect the real amount of debt because of the ways banks move loans off their books. Some loans are bundled and sold to savers as wealth-management products, which pay more than regulated deposits. Other assets are sold to non-bank institutions, including trusts, to lower bad-debt levels.