China’s Giant Banks Top This Ranking. And That’s a Cause for Concern

(Bloomberg Markets) -- In 1988, 9 of the 10 largest banks in the world were Japanese. Three years later the country's financial system, along with its lenders, collapsed, sending Japan into its infamous lost decade (or three, considering the country is still struggling to escape deflation and low growth). The nine Japanese companies in the top ranks by assets 30 years ago have since consolidated into four successors. Only one turns up in this year's ranking.

By 2007 all of the top 10 slots were filled by U.S. and European lenders. A year later the subprime mortgage meltdown hit the U.S. The sovereign debt crisis followed in Europe. Four of the 10 had to be bailed out by their respective governments. If they hadn't been rescued, they probably wouldn't exist today. U.S. and European economies, like Japan's, have contended for most of the past decade with low growth.

It's 2018, and the rankings teem with Asian banks again. This time the top four by assets are Chinese. Of course, this may not be a sign of where the next financial crisis will erupt. But in light of the recent precedents, it's a cause for concern.

The outsize growth of a single country's banks is a sign that credit expansion is faster there than in other nations—money borrowed by companies and consumers makes up the bulk of bank assets. China has been relying on speedy credit growth to keep its economy humming since the 2008 financial crisis. While nobody disputes the role of borrowing in China's ability to keep expanding, many, including the Chinese government, argue the country is different and won't collapse like Japan did in the early 1990s or the U.S. in 2008.

China's economy is managed closely by central authorities. Most banks are government-owned, financing comes overwhelmingly from domestic sources, and the government understands the dangers of surging credit. The country's leaders should be able to manage the leverage and avoid a crash. Or so the argument goes. “The main reason they've been able to last this long is the absence of inflation,” says Charlene Chu, a senior partner at Autonomous Research in Hong Kong who's long warned about the dangers of rising credit in the country. “Typically this much credit would be very inflationary, and the central bank hiking rates to fight it would make some bloated lenders crumble. But inflation is showing signs of revival.”

The credit boom has led to overheated real estate markets in many cities and overcapacity at state-owned companies. Chinese authorities have had their eyes on the problems for a while, but each time they try to crack down on borrowing, the economy starts to slow and they put the efforts aside to maintain their targeted 6 percent growth. “We have an economy addicted to credit,” Chu says. “So as soon as the government reins in lenders and credit pulls back, everybody screams for more credit, and the government relaxes the leash.”

The balance sheets don't even tell the full story. Chinese banks also have off-balance-sheet exposures that could come back to hurt them during a downturn, as U.S. banks experienced with their special investment vehicles during the 2008 crisis. The five Chinese banks on the top 10 list had an additional $1.1 trillion of assets kept off the balance sheet at the end of 2017, according to data compiled by Autonomous Research.

This time might be different, of course. But as the 2009 book by economists Carmen Reinhart and Kenneth Rogoff, This Time Is Different, demonstrated with data from 268 instances of financial turbulence in the past three centuries, it rarely is.

Onaran covers finance at Bloomberg News in New York.

To contact the editor responsible for this story: Jon Asmundsson at jasmundsson@bloomberg.net