A major shift in the global banking landscape is under way, with European and US banks focusing more on domestic activity and Chinese and other developing country banks expanding abroad.
Global cross-border capital flows have declined 65 per cent since 2007, and half of that is explained by a drop in cross-border lending flows. The largest global European banks, and some US ones too, are in retreat from foreign markets. But financial globalisation is far from finished — rather it is broadening and becoming more inclusive as developing economies, most notably China, step into the breach.
The eurozone has been at the forefront of the retreat from foreign markets among banks in advanced economies. The foreign claims of eurozone banks have fallen by $7.2tn, or 45 per cent, since 2007, and nearly half of that has been claims on other borrowers in the eurozone — particularly other banks, new MGI research finds. UK and Swiss banks have sharply reduced foreign assets since the crisis as well. US banks, which have always been less global than their European counterparts, have re-focused on growth at home.
In contrast, China’s four largest commercial banks have seen their foreign assets grow 12-fold since 2007 to more than $1tn. And that’s still only 9 per cent of their total assets. Foreign assets make up 20 per cent or more of the total assets in the largest banks in all advanced economies; if China’s largest banks follow that path, they could see tremendous growth in foreign lending ahead.
Most of China’s foreign lending to date has accompanied Chinese corporate investments abroad. Banks have stepped in to finance green field new investments, purchases of foreign businesses, and to build the infrastructure to make those investments work. From 2005 to 2016, Chinese foreign direct investment abroad increased more than tenfold, to $1.4tn. Some $32bn has been invested in Africa, where China is currently the fourth-largest but fastest-growing source of FDI. An estimated 10,000 Chinese companies have set up shop in Africa, according to McKinsey. In 2016, China passed a new threshold: its foreign direct investment, lending, and portfolio investment assets now exceed its massive central bank reserve assets, at $3.4tn and $3.2tn, respectively.
But whether China’s foreign lending and investment will prove to be profitable and sustainable remains to be seen. China’s domestic credit has grown at double-digit rates for the last decade, with debt of households, corporations and government entities increasing fivefold. New reports suggest that non-performing loans are rising. Even without sparking a financial crisis, this could create a wave of losses that hit their balance sheets and slow growth abroad. Indeed, many of the large global European and US banks now in retreat found that the margins and profits on their foreign business were lower than returns on their domestic business.
Beyond banks, China also has formidable players in the next wave of disruption now hitting global finance: digitisation. The value of China’s mobile payments related to consumption by individuals, for instance, was $790bn in 2016, 11 times that of the US. Fintech peer-to-peer (P2P) start-ups, many of them operating across borders, are proliferating. China’s biggest P2P lending and microfinance platform CreditEase in 2016 had plans to buy loan portfolios from two leading US online lenders. New players can build positions extremely quickly. Alibaba built a loan portfolio of $16bn in less than three years, becoming China’s largest seller of money-market funds in just seven months.
Advanced economies still hold the lion’s share of the global stock of foreign investments, at 85 per cent. But developing economies are making inroads. Their share of total foreign investment assets has risen from 8 per cent to 14 per cent over the past 10 years. On the McKinsey Global Institute’s new Financial Connectedness Ranking, China rose from 16th place in 2005 to eighth in 2015. Apart from China, no developing economy as yet has made foreign investments that exceed 1 per cent of the global total stock.
China’s rise in global finance looks set to continue. Regulators continue to ease restrictions on investing abroad and open the door to foreign investors. The number of qualified foreign institutional investors approved to participate in local stock and bond markets has grown ten-fold since 2005, to more than 300. In July 2017, the Chinese government launched its Bond Connect programme enabling foreign fund managers to buy and sell China’s $9tn of government, agency and corporate bonds without setting up an onshore account. The People’s Bank of China, meanwhile, has established swap lines with other 30 other countries since the crisis, totalling nearly $500bn in value, that can be drawn on to settle trade and other payments and promote financial stability. Call it “monetary diplomacy”.
Ten years on from the global financial crisis, there are indications that global finance is becoming more inclusive. Developing countries are becoming more prominent cross-border players, and the inexorable spread of digitised finance can only reinforce that trend. We must hope that China’s increasing prominence in global finance does not create global spillovers for countries least prepared to deal with them if its domestic debt challenges end badly. In this ever more connected financial system, a Chinese crisis could all too easily turn into a global crisis.
This article ran first in Financial Times.