How low is low in China’s gyrating stock markets?
How far can Chinese markets fall before systemic risks start to breakout?
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Benjamin Robertson
30 July 2015
How far can Chinese markets fall before systemic risks start to breakout?
The 3,300 level for the Shanghai Composite index is just that point, says BNP Paribas. At that level, the losses to margin lenders and leveraged investment products will start to hurt the wider financial system by destroying profit margins at the brokerage firms and weakening banks’ balance sheets.
“3300 is a psychological bottom for regulators as this could translate into systemic risk. We think 3500 may become the effective trigger level (for) regulatory intervention,” wrote BNP Paribas analyst Judy Zhang.
The Paris based bank assumes total market leverage of 5.4 trillion yuan as of June 30 with much of that lending taking place in May when the Shanghai benchmark index was around 4,500. The bank suggests the market would need to fall to 3300 points, a 13 per cent drop from Wednesday’s close, before key borrowing thresholds were breached and lenders asked investors to pony up or sell.
The Shanghai Composite has rallied to a 7-year peak by closing at 5,165.35 on June 12, having embarked on a months-long rally since ending at 2,289.86 on September 22 of last year. It plunged 30 per cent in a market rout before recovering somewhat and has since tried to hang onto the 4,000 point mark before falling under that level earlier in the week.
At 3,300, the average daily turnover and broker income would fall by 36 and 42.4 per cent respectively, according to a BNP Paribas review of five leading brokerages including Haitong Securities and Citic Securities, driving down year end profits by 40 per cent and return on equity by 9 per cent, assuming brokerages trimmed operating costs and laid off staff at the same time.
Brokerage stock prices have been among the heaviest fallers in Hong Kong since the mainland market turned south in mid June. Many brokers issued new shares earlier this year in part to support client margin lending services.
Though Zhang is confident brokerages won’t suffer heavy losses because of tight leverage ratios and “as long as brokers can liquidize the underlying collateral” she is concerned about how further market falls will impact brokerages own trading books, as well as the loans tied up in the more than 500 stocks still suspended since June, (including around 20 per cent of Shenzhen Composite index members).
Another big drop in asset prices will also impact bank books where BNP Paribas estimates 1.5 to 1.6 trillion yuan lies in on and off balance sheet market loan exposure. This represents only 0.9 per cent of total assets, though the number is higher at H share listed China Merchants Bank and China Everbright Bank, writes Zhang, and includes riskier umbrella trusts and structured products where leverage ratios hit 300 per cent.
The danger lies when stocks tied to these products fall their daily 10 per cent limit for several days consecutively making it tricky to liquidate holdings before equity buffers are destroyed.
In BNP Paribas’ “worst case scenario” a four day crash would destroy the banks own equity in these products, and reduce banking sector year end earnings by 4.3 per cent.
What do you think about China?
After what they said about not letting markets tank and cracking down on evil short sellers
And the fact that they're at the base of a 3-year uptrend channel base