China's watchdog cautions banks on household leverage

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China’s banking regulator warned on Friday about the rise in the country’s household leverage in the second quarter of this year while the economy is shifting to a consumption-drive model.

"We should learn a lesson from the sub-prime crisis in the US and not let the household leverage increase too fast," said Xiao Yuanqi, head of the prudential regulation bureau of the China Banking Regulatory Commission (CBRC), adding that regulators encourage consumers to use loans to finance their purchases of durable goods, education and travels in a bid to improve people’s living standards.

China’s household leverage increased to 47.4 percent in the second quarter from 46.1 percent in the first quarter, and the growth rate is relatively fast in the economy, according to China's Quarterly Deleveraging Report published by the National Institution for Finance & Development (NIFD).

Hefty mortgages have largely contributed to the rise of household debt, and the leveraging is moving from first- and second-tier cities to third- and fourth-tier cities.

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Yet the overly accelerating short-term consumer loans are alarming, as China’s short-term consumer loans rose 900 billion yuan (135 billion US dollars) in the first half of 2017 while the whole year of 2016 recorded 800 billion yuan (120 billion US dollars) in such loans, said the NIFD report.

The surge of short-term consumer loans has exacerbated concerns that consumer credit is being used to fund investments in property.

"Although the short-term consumer loan is not a decisive factor of the household leverage, its marginal influence has become bigger and bigger," warned the NIFD.

Regulators are vigilant about this potential risk. The People’s Bank of China has ordered commercial banks to clamp down on consumer loans being spun into the housing market.

Still, China's household leverage is among the lowest in the world. For comparison, the US peaked at 123 percent, and Australia is now at a worrying 168 percent.

The consumer market has the capacity to service higher debt.

The current level of household leverage is not excessive, said Daniel Morris, senior investment strategist at BNP Paribas Asset Management.

"With a slow rise in US interest rates putting muted pressure on Chinese rates, it is unlikely there will be concerns this year over borrowers’ ability to pay. Rather, increased consumption should decrease China’s reliance on exports as a source of economic growth," he said.

Background Information

Household leverage ratio: measures the indebtedness of households in relation with their income, that is their spending and saving capacity. High leverage ratios are often interpreted as a sign of financial vulnerability though not only debt and liabilities but also assets should be considered in such an assessment. High indebtedness levels generally increase the financing costs of the borrower, deteriorate balance sheet positions and may restrict access to new financing. -OECD

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