You are here

China to lend out its massive foreign exchange reserves

Section: Daily Dispatches

Looks like China aims to exchange more dollars for resources in the ground.

* * *

China is tapping its deep well of foreign reserves for overseas resource loans, benefiting banks through a major policy shift

By Zhang Yuzhe
Caixin Online, Beijing
Thursday, May 20, 2010

BEIJING -- The State Administration of Foreign Exchange (SAFE) is leading a policy adjustment that taps China's huge stash of foreign reserves for overseas loans through commercial banks.

Under an evolving reform project launched in recent months, SAFE has taken initial steps toward giving policy and commercial banks authority to handle loans for intergovernmental cooperation projects.

Major loan-for-oil swaps signed in recent months by China and several other countries marked a coming-out for the new policy.

Dispatch continues below ...


Prophecy Resource Corp. Appoints Rob McEwen to Advisory Board

Prophecy Resource Corp. (TSX.V: PCY, OTC: PCYRF) is pleased to announce the appointment of Rob McEwen to the company's Advisory Board. McEwen is a leading Canadian mining industry entrepreneur. He is the chairman and CEO of U.S. Gold Corp. and Minera Andes Inc. McEwen was the founder and former chairman and CEO of Goldcorp Inc., whose Red Lake Mine in northwestern Ontario, Canada, is considered to be the richest gold mine in the world. During his tenure at Goldcorp, McEwen transformed the company from a collection of small companies into a mining powerhouse, growing its market capitalization from $50 million to approximately $8 billion.

For Prophecy Resource Corp.'s complete statement:

The adjustments are designed to help China diversify its foreign currency assets and provide a channel for some of the US$ 2.4 trillion in reserves held by the central bank.

The reforms also expanded SAFE's responsibilities beyond its traditional role of managing foreign exchange reserves, effectively turning the agency into a foreign currency lender.

The new forex direction dates from the end of last year, when the State Council asked SAFE to take the lead in projects including a Chinese loan-for-Russian oil exchange deal. The agency was also told to study additional innovations for policy lending.

Meanwhile, SAFE has been looking at ways in which domestic financial institutions can cooperate through various loan programs to help Chinese enterprises expand abroad.

Since 2009 China has signed loan-for-oil agreements worth more US$60 billion in recent months with Russia, Venezuela, Kazakhstan, Turkmenistan, and other countries. Altogether, these agreements have given China the rights to import nearly 75 million tons of crude oil every year.

Under the China-Russia bilateral agreement signed February 17, for example, China will provide Russia US$25 billion in long-term loans in exchange for 15 million tons of crude oil annually between 2011 and 2030.

The agreements put China's forex pool to work at a relatively young age: The nation's foreign reserves have grown substantially since the country joined the World Trade Organization in 2002.

Before that, forex reserves growth was less than US$50 billion a year. But the growth rate soon jumped to an average 33 percent per year.

The central bank's forex holdings have doubled to today's US$2.4 trillion from the US$1.2 trillion on hand in September 2007, when the government created an overseas investment arm, China Investment Corp.

The current cash stash is far more than the government technically requires, giving policymakers a key reason to pursue policy lending. In theory, the central bank is required to retain only enough foreign currency assets with strong liquidity to handle three months of imports and short-term external debt. A reasonable upper limit for meeting this requirement now would be US$600 billion.

Moreover, the central bank is interested in the policy loan project because it is actively pursuing safe, profitable investment channels for forex reserves.

After getting its recent marching orders from the State Council, SAFE's first step was to sign an agreement with China Development Bank Corp. (CDB) to handle so-called "entrusted loans." The deal gave CDB authority to act as SAFE's agent for overseas investment loans, primarily to Chinese enterprises that go abroad.

An entrusted loan is a three-party credit tool in China in which one non-bank entity lends to another through a cooperating bank. These are off-balance sheet transactions, and the bank receives representative fees that count as intermediate business income.

Since SAFE lacks risk management capacities, such as pre- and post-loan appraisals, risk control for entrusted loans largely depend on cooperating banks such as CDB. That means "banks are essentially working for SAFE, and interest margins from foreign currency financing projects will be directly handed over to SAFE," said a commercial bank source, who added these deals include a degree of moral hazard.

Based on the "basic strategic intent" of the government, "this model has some definite benefits," said one financial expert. "Still, under this new model, SAFE will be forced to take on even greater risk responsibility."

And that raises a warning flag about government policy direction. "China's biggest problem is that all the risk is concentrating toward the government," the expert said.

SAFE's first pick for entrusted loan projects was CDB, which took the lead in arranging many of the latest oil deals. The two agencies signed an agreement that divides overseas investments into new and old projects. CDB agreed to a commission range between 1 and 2 percent for new projects.

Most of CDB's international operations last year involved loans-for-resources projects, including 10-year oil deals worth more than US$ 10 billion with countries including Russia, Brazil, and Venezuela. CDB also took the lead in syndicated loans with other banks.

Not everyone at CDB is happy with the policy program. A CDB source said the bank is currently in a transition period and should expand its fund reserves for long-term, stable profits. The source said the "1 to 2 percent commission" promised by SAFE "is not high" compared with profit margins from regular loans.

The new lending model also will affect cost budgeting and risk management at CDB, the source said. "The entrustment agreement between SAFE and CDB allows SAFE to directly take on new projects," the source said. "SAFE will act as the organizer and primary arranger of syndicated loans."

"CDB is taking on some operations that have a relation to policy lending," said a source at the government investment arm Central Huijin Investment Ltd. "Under the current system, one may well say that this model opens up a new path. "However, it is still only suitable as a transitional arrangement."

One reason for the program's temporary nature is that the government is assuming risk.

But some banks are not complaining. Off-balance sheet operations protect banks from risk, said a source at Bank of China, a state-run commercial bank. Another plus is that SAFE's entrusted loan model can give banks access to additional foreign currency capital, the source said.

Moreover, the model "does not take capital, reduces pressure on capital and allows banks to earn a simple commission fee," the source continued. "Hence, the merits outweigh the drawbacks."

As for drawbacks, a China Eximbank source said the entrusted loan model raises the possibility of moral hazard. And SAFE assumes all risk as lender and interest payment beneficiary.

"Allowing SAFE to collect interest margins means the main source of profits belongs to SAFE," a commercial bank source said, before raising a crucial question: "In this case, who would take primary responsibility for post-loan management and risk?"

By taking on risk, one financial expert said, SAFE is now stepping out from behind the scenes to the center of China's financial stage.

"The biggest risk involved with overseas investment projects is country risk," the Eximbank source said. "Loan amounts for medium- to long-term loans overseas are huge and limited to one country. Hence, the risk is relatively concentrated."

* * *

Join GATA here:

World Resource Investment Conference
Sunday and Monday, June 6 and 7, 2010
Vancouver Convention Centre
Vancouver, British Columbia, Canada

* * *

Support GATA by purchasing a colorful GATA T-shirt:

Or a colorful poster of GATA's full-page ad in The Wall Street Journal on January 31, 2009:

Or a video disc of GATA's 2005 Gold Rush 21 conference in the Yukon:

* * *

Help keep GATA going

GATA is a civil rights and educational organization based in the United States and tax-exempt under the U.S. Internal Revenue Code. Its e-mail dispatches are free, and you can subscribe at:

To contribute to GATA, please visit:


Coming Friday-Sunday, June 11-13, at the Dallas-Fort Worth Airport Marriot:
The Anglo Far-East Bullion Co.'s Gold and Silver Conference

The conference will explore the dangers and opportunities in today's bullion markets and the need for investors to diversify bullion holdings outside of bullion banking and commodities markets. Speakers will include David Morgan of, Gold Anti-Trust Action Committee Chairman Bill Murphy, and Duncan Cameron and Philip Judge of Anglo Far-East Bullion Co. The earliest conference attendees on Saturday will be able to schedule one-on-one interviews for personal consultation with Anglo-Far East's experts on Sunday.

To learn more about and register for the Anglo Far-East Bullion conference, please visit: