Excessive credit growth in China is signalling an increasing risk of a banking crisis in the next three years, a report from the Bank for International Settlements (BIS) says.

An early warning of financial overheating – the credit-to-GDP gap – hit 30.1 in China in the first quarter of this year, the financial watchdog said in a review of international banking and financial markets published on Sunday. Any level above 10 indicates risk of a crisis in any of the three years ahead, the BIS said.

China’s indicator is way above the second-highest level of 12.1 for Canada and the highest of the countries assessed by the BIS. Debt has played a key role in shoring up China’s economic growth following the global financial crisis. Outstanding debt reached 255 per cent of GDP in 2015, fuelled in large part by a surge in corporate borrowing, up from 220 per cent just two years earlier.

Strong mortgage demand

China’s bank lending in August more than doubled from the previous month, with much of the gain down to strong mortgage demand. Indeed, China’s top banks are lending more to homebuyers and developers than at any time since at least the global financial crisis. The credit-to-GDP gap takes into account the current credit-to-GDP and expected long-run trends.

But a China strategist at an international hedge fund said international historical experience is not necessarily applicable to China. The strategist could not be identified as he is not authorised to speak to the media.

The BIS also said the estimated debt service ratio – which measures principal and interest payments relative to income – is at 5.4, which is a “potential concern.”

This underlines the default risk as borrowers struggle to repay loans. Some analysts argue a weakening in banks’ capital strength raises the prospect that the government may have to inject more than $100 billion to shore them up.

Despite the concerns surrounding China's debt, UBS analysts said in a report earlier this year that they do not expect an imminent banking crisis. A high domestic savings rate, underdeveloped capital markets, a relatively closed capital account and government ownership of banks and many large borrowers mean no one can easily "pull the plug" on its credit cycle, they said.

Debt-to-GDP could reach 300 per cent before 2020, UBS said. – (Reuters)