By Jake Spring and Xiaoyi Shao
BEIJING (Reuters) - Cautious Chinese banks issued far less credit in December than expected despite a surprise rate cut by the central bank, driving cash-starved companies into the shadow banking system in a major blow to the government's financial reform efforts.
The weaker-than-expected loan data indicates Beijing's traditional reliance on credit to spark the economy is losing its effectiveness, posing a further challenge to policymakers as they look for ways to avert a sharp slowdown in 2015.
Despite instructions from the central bank to extend more loans in the final months of last year, analysts said banks were reluctant to lend as companies struggled to pay off existing debts and bad loans spiked.
"The slowdown of new loans in December suggests that China's commercial banks are still concerned about the credit risks in the traditional sectors," Liu Ligang, China economist at ANZ, wrote in a note.
"As the economy continues to slow and the risk of deflation looms large, we expect monetary policy to be eased further."
Chinese banks lent 697.3 billion yuan (74 billion pounds) in December, central bank data showed on Thursday. Economists polled by Reuters had expected lending to be little changed from the previous month at 852.7 billion yuan.
The central bank unexpectedly cut interest rates for the first time in more than two years in late November in an attempt to ease strains on companies desperate for funds and also loosened lending policy late in the year.
China is likely to report next week that economic growth last year was the slowest in 24 years, and analysts predict a further loss of momentum in 2015 even if the government rolls out more stimulus. A cooling property market, excess capacity at factories and sluggish investment are all weighing on demand.
Growth likely slowed to 7.2 percent in the fourth quarter, putting the economy on track to undershoot the official 7.5 percent target for the full year, a Reuters poll showed. Some economists see 2015 growth below 7 percent.
If the GDP data proves worse than expected, some analysts say the People's Bank of China (PBOC) could cut interest rates further or lower reserve requirement ratios (RRR) for all banks. A reserve ratio cut would give banks greater capacity to lend, but many market watchers question if they would be willing to increase their exposure as economic conditions deteriorate.
Expectations of more stimulus made China's stock market the top performer in the world last year. Shanghai indexes (SSEC) rose on Thursday as the weak loan data fuelled hopes of more support, taking their gains to over 60 percent since June.
RESURGENCE IN SHADOW BANKING
The loan data also showed more companies are lending to each other, possibly as big banks grow more risk averse. As intermediaries, banks charge a fee for these so-called "entrusted loans" but do not have to carry them on their books.
Total social financing (TSF), a broad measure of liquidity designed to also capture some lending outside of traditional banking, jumped to 1.69 trillion yuan in December compared with 1.15 trillion for November.
The "shadow banking" portion of TSF was the highest since January, reversing a shrinking trend that had taken hold in the second half of the year as the government stepped up its long campaign to clamp down on riskier and less regulated forms of lending.
"Shadow banking is back with a vengeance. I'm not sure why the year ended this way but it's clear that there is a lot of money creation outside of the banking system," said Dariusz Kowalczyk, an economist at Credit Agricole CIB.
"That is a step back in the reform process."
New renminbi loans for the year overall rose about 10 percent to 9.78 trillion yuan from 8.89 trillion yuan for 2013.
Broad M2 money supply measure grew 12.2 percent in December, below expectations and easing from November.
Outstanding yuan loans increased 13.6 percent in the final month of the year, compared with 13.4 percent in November.
The government encouraged a massive run-up in debt to prop up the economy during the global financial crisis and subsequent lending levels, particularly to state-owned firms and local governments, have remained high.
At the same time, the quality of the credit is being called into question, as many companies may merely be using new loans to service existing debts rather than for productive investments that feed economic growth.
Many companies are also complaining of high costs when they are able to obtain financing.
Creditors are on high alert for whether the central government will allow failing companies to default, particularly after property investment firm Kaisa Group (HK:1638) missed a bond payment, leaving foreign investors wondering if they will be protected.
CAPITAL FLIGHT
Other data on Thursday suggested speculative, "hot money" flowed out of China late last year amid increased market jitters about whether the economy may be at risk of a hard landing.
China's foreign exchange reserves, the world's largest, fell slightly to $3.84 trillion at end-December from $3.89 trillion at end-September, the second quarterly decline in a row.
Foreign reserves fell again despite a major trade surplus, indicating money was flowing out of the country and potentially undercutting the impact of further PBOC policy easing, said Kevin Lai, a senior economist at Daiwa Capital Markets.
"The PBOC will have to do it but when they try to release money into the system, the money leaves the system. That means that policy is being fully neutralised, there is very little policy impact as a result of the money outflows," said Lai.