July data highlight evaporating demand for credit

Total social financing collapses to 273.1b yuan, down 86.2% from June

With China's financial landscape still ringing with the central bank's calls to ease credit conditions, bank lending collapsed in July.

Figures released Wednesday from the People's Bank of China (PBOC) show social financing, a broad measure of credit within the economy, equaled just 273.1 billion yuan ($44.37 billion) last month, down from 1.97 trillion yuan in June. Meanwhile, new yuan loans in July stacked up to just 385.2 billion yuan, compared with 1.08 trillion yuan the previous month.

These results are all the more startling since they follow so quickly on the heels of government moves to promote bank lending through targeted reserve requirement ratio cuts and loan-to-deposit ratio adjustment.

Indeed, to quell market anxieties, the PBOC issued a statement which pinned July's unexpected slowdown on a confluence of seasonal factors, flagging loan demand and an increase in credit risk. Additionally, the central bank linked the plunge in social financing to tighter regulatory controls. Moreover, some 30 to 50 billion yuan per day in loans has been flowing into the economy since the start of August, the central bank explained, which could support an uptick in lending this month.

This interpretation by the central bank isn't altogether unreasonable, but it remains to be seen though whether July's data indicate the beginning of a new trend or are merely an aberration. In the latter case, stimulus policies aimed at the general economy and the financial system will gradually push the scale of social financing back to reasonable levels. But if this recent skid snowballs into a trend, planners and policymakers will need to take action to prevent the deteriorating credit environment from affecting the real economy.

Based on the central bank's analysis, it's hard to tell which had a stronger hand in July's credit figures: the market or the government. Bringing in data from other sources, it seems that waning demand for credit - particularly for loans connected with the real estate market - was likely a prime factor in last month's lending drop. Plus, with China's slowing economy bringing regional risks to the forefront, commercial banks are now becoming more cautious with their credit.

We can see signs of insufficient market demand in China's fluctuating interbank rates. Within the context of July's social financing tumble, the country's benchmark interbank borrowing rate averaged 3.41 percent in July, 0.56 percentage point higher than June, but 0.13 percentage point lower than the same period last year. Compared with the spikes that squeezed Chinese bankers during the "cash squeeze" in June 2013, last month's drop in social financing has been occasioned by no dramatic shocks to interest rates.

Weakening demand for housing is another obvious factor, although perhaps more troubling is the anemic business growth that's now taking place in China's real economy. Many businesses are having an increasingly difficult time raising funds, let alone generating a profit. Moreover, the staggering cost of fundraising is putting companies and officials alike in a hard situation.

If enterprises in China's real economy continue to suffer, it's hard to imagine a bright future for the broader economy. The financial system is like the circulatory system of the real economy - once demand for blood starts to weaken, the results can be fatal.