If the dark predictions are going to come true — that the market turmoil out of China will lead to "another 2008" — it will have to be a very different kind of crisis than the original.
Six months after sell-offs in Shanghai began to reverberate through markets worldwide, bond-rating agencies continue to rate Chinese banks' credit as investment grade, suggesting that if China does lead the world into recession, it will be a different affair than the sudden, sharp downturn catalyzed by the collapse of Lehman Bros.
A measure of default risk used by Moody's Investors Service puts the risk of any of the Big Four Chinese banks — Bank of China, the Industrial and Commercial Bank of China, China Construction Bank and Agricultural Bank of China — defaulting in the next year at no more than 1.5 percent, and for some as little as 0.5 percent, said Samuel Malone, director of specialized modeling at Moody's Analytics, the economic forecasting and risk-modeling unit of Moody's.
Even with nearly $11 trillion of assets and loans that reach into all sectors of China's $10.3 trillion economy, for now, experts see little likelihood the banks themselves will be a problem; China's largest banks are all controlled by a government that has the determination and resources to prop them up if necessary. And their ties to U.S. institutions are narrow enough that bond-rating agencies don't foresee anything like the financial contagion of 2008, when liquidity problems quickly spread from bank to bank and nation to nation as the extent of the mortgage crisis became clear.
"What's happening in China is not comparable to what happened in the U.S., and I don't think there will be a replay," said Todd Lee, China economist for IHS Global Insight. "In the U.S., there was a risk aversion that caused a credit crisis. The difference is that the state can pretty much force the affiliated banks to lend.''
At CNBC's request, Moody's Analytics ran a computer model of the likely correlation between problems at China's banks and the financial health of U.S. institutions. Moody's relied on a method called Granger causality, named for Nobel Prize-winning economist Clive Granger, which uses one set of data (in this case, market perceptions of Chinese banks' risk) to predict another (the risk to U.S. institutions) to determine the likelihood of default between U.S. and Chinese banks. Some of its conclusions:
- The default risk of the largest Chinese banks has risen since its historical lows in 2013 but remains below levels seen in the U.S. before the financial crisis. The megabank with the highest risk score is the $3.36 trillion Industrial and Commercial Bank of China, Malone said.
- Large U.S. banks do not appear to be vulnerable to China's problems at this point, thanks in part to capital buffers they have built at regulators' insistence since the 2008 crisis.
- The two Chinese banks that most influence markets' view of U.S. banks' health are the Bank of China and the Industrial and Commercial Bank of China, Malone said, because historically, changes in their risk profile have preceded changes in market views of Western institutions more strongly than heir peers have. That's why investors are likely to keep an especially close eye out for signs of trouble at those two institutions, he added.
- Statistical measures of the connection between how markets see default risks at China's banks, and how risky it believes U.S. institutions are, hit a post-2008 low in mid-2015 but have risen modestly in the last six months.
- Chinese securities firms, like Haitong Securities Ltd. and Huatai Securities, are bigger default risks than China's commercial banks, Malone said. But they are much smaller: Haitong, the larger of the two, has only about U.S.$10 billion in assets. These firms' risk has less influence on other financial institutions than do swings in market perceptions of the Big Four, he said.
"It's one thing for a bank to be risky,'' Malone said. "It's another for it to be both interconnected with other banks and risky.''
To date, China's banks have not experienced anything like the cataclysms that rumbled through U.S. and European institutions between 2007 and 2009. Neither have their problems resulted in any significant shortages of credit: Retail sales in China rose 11 percent in December 2015, and housing sales have begun to rebound from an earlier dip.
The U.S. financial crisis drove a near-50 percent drop in sales of new cars and trucks, and a collapse of the market for new homes, driven largely by unemployment fears and problems getting deals financed. Even seven years later, the mortgage market remains dependent on government-backed Fannie Mae and Freddie Mac, despite the hopes of Congress and the Obama administration to have turned over their role of providing financing to lenders to the private sector by now.
Neither are the biggest U.S. institutions showing signs of worrying about their China exposures. Citigroup was the only Big Six U.S. bank to discuss China in detail on its most recent conference call, saying it has about $20 billion in total exposures as of last Sept. 30 — about a third of that in government bonds and less than $9 billion of commercial loans. In October, JPMorgan Chase said it had only minor exposures to China's markets to facilitate client trading.
That said, China's banks are in worse shape than a year ago, by many measures. Reported loan delinquencies have risen to 1.59 percent of loans as of Sept. 30, up from 0.95 percent at the end of 2012, Moody's Investor Service says. And critics have seized on banks' decisions to classify fewer loans whose borrowers are more than 90 days late on their payments as non-performing, saying banks and the government are trying to paper over the extent of a fast-growing problem.
Moody's Investor Service cut its outlook for China's bank sector to negative from stable, on Dec. 11. It pointed to the loan-loss problems, as well as an increase in overall borrowing to 209 percent of gross domestic product, from 193 percent a year ago, that it says raises systemic risk.
But all four of China's largest commercial banks, each majority-owned by the government, are still rated A1/Stable — six notches above speculative grade and higher than all six of the top U.S. banks, which are rated A2 or A3. Bigger problems lurk in smaller Chinese banks that are less systemically important, the ratings agency said.
Under the formulas used by Moody's Investor Service, no major U.S. bank has more than a 0.25 percent risk of failure, Malone said. The four biggest U.S. commercial banks — JPMorgan Chase, Bank of America, Citigroup and Wells Fargo — had a total of $6.5 trillion in assets in mid-2015, according to the Federal Reserve.
China's banks are mostly funded by deposits rather than the capital markets, said Grace Wu, an analyst for Hong Kong-based Fitch Ratings. That makes them less vulnerable to short-term twists in the mood of markets, she said. They also have loan-loss reserves, collectively, that are nearly twice as big as the amount of loans that are 90 or more days past due, according to Moody's Investors Service.
Non-performing loans, at least for now, are still below levels reached in the U.S. in 2008, according to the World Bank. Lending, while growing even faster than China's economy in recent years, has not been as obviously slipshod as anything that happened in the U.S. mortgage market, Wu said. Until recently, she added, 50 percent down payments were common for houses and apartments, even with China's highly inflated property values. Even now, at least a 25 percent down payment is required for most mortgages. But authorities use the banks to fund policy objectives, from driving manufacturing growth to propping up stock markets, making it difficult to determine whether all of those loans and investments are as healthy as reported.
China's banks also benefit from the explicit backing of the government there, in contrast to the U.S., where bank bailouts remain controversial seven years after the crisis. China's central bank also has much more room to lower interest rates than does the U.S. Federal Reserve, which has set the target range for its key policy rate at 0.25 percent. The current Chinese base interest rate is 4.35 percent.
To be sure, China's banks could be in worse shape than markets think. The extent of the U.S. financial crisis was far from clear in early 2008, and contrarian investors had been warning of trouble signs in housing finance as early as 2005, just as skeptics at firms like CLSA and Macquarie Securities have argued in recent months that reported loan-loss problems at China's banks far understate reality.
The problems China's banks have are focused in manufacturing and wholesaling — and an increasing number of those borrowers are relatively small businesses, Moody's said. That raises the risk that their problems are not well understood or that they could worsen.
But ratings agencies think China's banking sector poses contagion risk for Western institutions only if the Chinese government loses the market's confidence, Wu said. Fitch reaffirmed the government's investment-grade bond rating last month.
"The moment people doubt the state's ability to control the [financial] system, the more you have cracks in confidence," Wu said. "It's not that we're not concerned. But the state has reasonable resources to contain that risk.''
-By Tim Mullaney, special to CNBC.com