What caused the fall of discounting bills in September?

Yesterday the FT Alphaville had an interesting blog post on China’s banking system. Among the major financial media it was probably the first who noticed the very detailed changes in China’s loan structure. If we look at the year-to-date number, the outstanding amount of discounted bills, short-term loans and medium &long term loans rose by RMB 831.3B, 3.33T and 2.36T, respectively. However, in September, the outstanding amount of discounted bills dropped by more than 200B while short-term loans and medium and long-term loans continued to rise from the previous month.

The FT Alphaville then threw out very important questions: what are these discounted bills, and why did they flourish and then suddenly begin to dry up? And here is their explanation, quoting Michael Werner from Bernstein.

As for their recent popularity, Werner outlines how they were used to reach end-of-quarter loan-to-deposit ratios:

In the past, some banks would issue bank acceptance bills in order to drive deposit growth as clients would be required to post margin deposits. In this way, a bank could report an increase in deposits without growing its loan book. Thus the bank’s LDR would decline. As such, banks are more inclined to issue bills at quarter–end.

This is what he believes happened:

Based on Mainland media, CBRC prohibited some smaller banks (which have a larger penchant for this behavior) from issuing bills to discourage this practice. In addition, we believe the clampdown on the entrusted loan business (which is an off-balance sheet method for small banks to channel funds from large banks to clients) is resulting in a decline of these off-balance sheet items.

Reuters’ report has a different take on the regulatory crackdown; it reports that the PBoC plans from 2013 to stop banks from using the products to hide their off-balance sheet lending. Either way, it seems that some regulatory pressure was probably brought to bear on discounted bills.

It is completely correct that issuing bank acceptance bills requires customers to put margin deposits so that LDR will drop because of the issuance. However, the issuance of bank acceptance bills is different from the process of discounting those bills. The issuance does not count as a loan in credit quotas while discounting a bill does. To be more specific, when a bank issues an acceptance bill to a firm (so that the firm can send the bill to its business counterparty), it is not counted as a loan; only when someone asks the bank to discount the acceptance bill, it is counted as a loan. As a result, the CBRC prohibiting small banks from issuing bills would have very little impact on the amount of discounted bills. In fact, the effectiveness of the regulatory change is also very doubtful. The more recently Total Social Financing data published by the PBOC revealed that undiscounted acceptance bills increased by 216.3B in September, the second largest this year. Entrusted loans also rose by 144.9B, the largest increase since January. We have not yet seen a decline of off-balance sheet businesses. The reason why the amount of discounted bills dropped in September, we believe, is that the potential profit from discounting bills has fallen along with discounting interest rates. 

Figure 1 the monthly increase of short-term loans, medium &long term loans and bill discounting (Billion RMB)

Figure 2 the monthly increase of entrusted loans and undiscounted acceptance bills (Billion RMB)

Chen Long

Central Banking Seminar