Chinese lenders have a massive challenge: They can’t lend enough inkeinspires

China’s commercial banks have a huge problem.

While consumers and businesses are pessimistic about the prospects for the world’s second-largest economy, loan growth has stalled. Beijing’s stimulus measures have so far failed to boost consumer credit demand and have yet to trigger a significant rebound in a faltering economy.

So what do banks do with their money? Buy government bonds.

Chinese sovereign bonds have seen a strong rally since December, with 10-year yields plunging this month to all-time lows, falling around 34 basis points, according to LSEG data.

“The absence of strong demand for consumer and business loans has led to capital flows into the sovereign bond market,” said Edmund Goh, head of bond investments at abrdn in Singapore.

That said, “the biggest problem inside the country is the lack of assets to invest,” he added, because “there is no sign that China can emerge from deflation for the moment”.

Total new yuan loans in the 11 months through November 2024 fell more than 20% to 17.1 trillion yuan ($2.33 trillion) from a year ago. according to data released by the People’s Bank of China. In November, the new bank loans amount to 580 billion yuancompared to 1.09 trillion yuan a year earlier.

Demand for loans has failed to recover despite the broad stimulus measures that Chinese authorities began to unveil since last September, when the economy was on the verge of missing its growth target for the whole year, “around 5%”.

Goldman Sachs forecasts growth in the world’s second-largest economy will slow to 4.5% this year and expects credit demand to have slowed further in December compared with November.

“There is still a lack of demand for quality loans as private companies remain cautious in approving new investments and households also tighten the purse strings,” said Lynn Song, chief economist at ING.

For this year, the authorities have committed to making stimulating consumption a top priority and reviving demand for credit thanks to a reduction in financing costs for businesses and households.

Investors may continue to seek “risk-free sources of return” this year due to the high level of uncertainty related to possible tariff measures from abroad, Song said, noting that “a few points of questions remain about the strength of domestic political support.”

The slowdown in lending comes as mortgages, which once fueled credit demand, are still at an all-time low, said Andy Maynard, managing director and head of equities at China Renaissance.

Domestic Chinese investors face a lack of “investable assets to invest money in, both in the financial market and the physical market”, he added.

Official data showed on Thursday that China annual inflation in 2024 amounted to 0.2%reporting that prices barely increased, while wholesale prices continued to fall, down 2.2%.

Institutions are increasingly bullish on government bonds due to the belief that economic fundamentals will remain weak, coupled with fading hopes for strong political policy, said Zong Ke, portfolio manager at Wequant, an asset manager based in Shanghai.

Ke said current policy interventions are only “efforts to prevent economic collapse and cushion external shocks” and “simply to avoid a free fall.”

The 10-year U.S. Treasury yield has risen at a faster pace since June and a rise on Wednesday sent the yield to a record high of 4.7%, approaching levels last seen in April.

Widening yield spreads between Chinese and US sovereign bonds could risk encouraging capital outflows and putting further pressure on the yuan, which is weakening against the greenback.

China’s Chinese yuan hit a 16-month low against the dollar on Wednesday, while the offshore yuan has been falling for several months since September.

“You have the perfect storm,” said Sam Radwan, founder of Enhance International, citing falling government bond yields, the prolonged housing crisis and the impacts of rising tariffs as risk factors, weighing on the confidence of foreign investors in onshore assets.

While reducing the appeal of Chinese bonds to foreign investors, widened yield spreads with US Treasuries have little impact on the performance of Chinese government bonds due to the “small share of foreign funds” , said Winson Phoon, head of fixed income research at Maybank. Investment banking group.

Lower yields offer a silver lining for Beijing – lower financing costs – as policymakers are expected to increase new bond issuance this year, ING’s Song said.

Beijing unveiled a $1.4 trillion debt swap program in November, aimed at easing the local government financing crisis.

“For much of 2024, policymakers acted to intervene whenever 10-year yields reached 2%,” Song said, noting that the PBOC “quietly stopped its intervention” in December.

Investors expect the central bank to unveil further monetary easing measures this year, such as further reductions in the main interest rate and the amount of cash banks must hold as reserves. At the turn of the year, The People’s Bank of China announced that it would cut its key interest rates at an “appropriate time”.

“The bank will enrich and improve its monetary policy toolbox, will purchase and sell Treasury bills and will be attentive to the evolution of long-term yields,” according to the declaration of January 3.

However, the outlook for lower rates will only keep the bond rally going.

Economists at Standard Chartered Bank predict the rise in bonds will continue this year, but at a slower pace. The 10-year yield could fall to 1.40% at the end of 2025, they said in a note on Tuesday.

Credit growth could stabilize by mid-year as stimulus policies begin to boost some sectors of the economy, economists said, leading to a slower decline in bond yields.

China’s central bank said Friday it would temporarily stop buying government bonds due to excess demand and limited supply in the market.