There has been much conjecture since 2014 about the increasing numbers in
the “precious metals” category on the balance sheets of listed Chinese
commercial banks. By the end of 2015 China’s largest banks were
holding RMB 598 billion in precious metals.
Some analysts think that the precious metals on Chinese commercial bank
balance sheets are gold reserves purchased on behalf of the Chinese central
bank, while others surmise that Chinese banks buy gold at the Shanghai Gold
Exchange (SGE) and then lend it out so the precious metals on the balance
sheets solely represent leased gold. In latter analysis it’s then assumed the
leasing inflates the amount of gold withdrawn from SGE designated vaults.
Most certainly there is leased gold on Chinese banks’ balance sheets, but
this can hardly influence SGE withdrawals, as I have previously explained.
Read this
and this
article for more information.
What do we know beyond the gossip about the precious metals
holdings on Chinese commercial bank balance sheets?
From studying the annual reports of the respective banks and
additional documentation we know the precious metals can be at least the
following things (if I find more clues this post will be updated):
- Gold savings that belong to the banks’ customers
- Gold inventory for the banks’ retail gold
business
- Gold leasing business
- Gold held for hedging purposes
Since the Chinese silver market was liberalized much earlier than gold I
don’t think there is any edge for Chinese commercial banks to have a
predominant role in the silver market. So, probably most of the precious
metals on the balance sheets in question are gold related.
Below is an overview of the precious metals holdings of listed Chinese
commercial banks as of 31 December 2015, measured in yuan (RMB). There are 16
listed Chinese commercial banks on China’s A-share market but Huaxia Bank
didn’t disclose its precious metals holding in its annual report. If all
aggregated precious metals holdings relate to gold, the upper bound is
approximately 2,682 tonnes of gold.
1. Customers’ Gold Savings
A substantial amount of the precious metals reflect (fully backed)
customers’ gold deposits in the form of Gold
Accumulation Plans (GAP), recorded as an asset and a
liability on the balance sheets of the banks. However, to me it’s
unknown how much gold is exactly accumulated in China through GAPs.
Let’s go through the annual reports of the Chinese banks having the
largest precious metals holdings, seeking for information with respect to
GAPs.
According to the 2015 annual
report of Bank of China (BOC):
Precious metals comprise gold, silver and other precious metals.
The Group retains all risks and rewards of ownership related to precious
metals deposited with the Group as precious metals deposits, … and
it records the precious metals received as an asset. A liability
to return the amount of precious metals deposited is also recognized.
From the BOC
website its GAP
seems to be in its infancy, so I don’t expect it to comprise much gold. ICBC
on the other hand, introduced a GAP in 2010 and is thought to be largest in
China.
From reading ICBC’s 2015 annual
report [brackets added by me]:
Seizing the opportunities arising from customers’ wealth increase
and capital market growth, the Bank made efforts to establish a mega asset
management business system across the whole value chain and enhance its
specialized operating capabilities on the strength of the Group’s asset
management, custody, pension and precious metal businesses, …
The [ICBC] Group records the precious metals received as an asset.
A liability to return the amount of precious metals deposited is also
recognized. …
On ICBC’s website
we read:
统计显示,截至2014年末,工行积存金的业务规模已超过250吨,同比增长超过150%,积存客户数量已超过100万户。
According to statistics, by the end of 2014, the business size of
ICBC’s GAP was more than 250 tonnes, a 150% YOY increase. GAP clients are
more than 1 million.
In the 2015 annual
report by China Construction Bank (CCB):
While consolidating our traditionally advantageous businesses in
housing finance and cost advisory service among other things, we actively
expanded our presence in … precious metals.
The Bank supported product innovation, provided and optimized new
products such as … gold purchase and saving.
The Bank proactively responded to changes in the precious metals
market via pursuing marketing expansion, enlarging customer base and
enforcing product innovation. The Bank launched innovative products and
business models, including gold accumulation plan ….
To me it’s unknown how much gold CCB’s GAP
comprises.
All in all, precious metals on the listed Chinese commercial
banks’ balance sheets can be gold savings held on behalf of clients instead
of reflecting the banks own metals.
(Likely, gold saved in Chinese GAPs is bought and withdrawn from SGE
designated vaults.)
2. Bank Gold Inventory
Chinese banks offer a wide range of retail gold products for sale.
Naturally, any gold inventory is recorded on the balance sheets. More from
ICBC’s 2015 annual
report:
To echo the changes in market demands, the Bank developed a
variety of new brands on assorted themes and introduced a slew of products,
e.g. Chinese Zodiac Coins and Panda Gold and Silver Coins, under agent sales.
The Bank expanded the online channels, through which the flagship store “ICBC
Gold Manager” witnessed substantial growth of sales, and it also
piloted the direct distribution of logistics suiting to the characteristics
of e-commerce.
According
to the World Gold Council roughly 60 % of Chinese retail investment
demand is supplied through commercial banks.
Additionally, I have no proof, but it can be that some of
the inventory in the vaults of the SGE is appearing on the Chinese
commercial bank balance sheets. Most of the banks listed in exhibit
1 have a PBOC gold import license. Once the bullion is imported into the
Chinese domestic gold market, often done through consignment, it must be sold
first through the SGE. By the time it has arrived in SGE designated vaults
and before it’s sold, possibly it’s shown on the balance sheet of the
importing bank.
3. Gold Leasing
Probably the largest share of the precious metals on the balance
sheets have to do with gold leasing. At the moment, there are
no official accounting rules or guidelines related to how to record bank’s
gold leasing activities. (In this post, I don’t distinguish between gold
leasing and gold lending because the essence is the same.) However,
most banks seem to still put gold leasing activity in the precious metals
category of their balance sheets.
According to the A-share annual report
of the Bank of Communications [brackets added by me]:
与本集团交易活动无关的贵金属包括经营章币销售等按照取得时的成本进行初始计量,以成本与可变现净值两者的较低者进行后续计量。与本集团交易活动有关的贵金属包括贵金属租赁、拆借等按照公允价值进行初始计量和后续计量,重新计量所产生的公允价值变动直接计入当期损益。
Precious metals that are not related to the Group’s trading activities
including coins and medallions sales are initially measured at acquisition
cost and subsequently measured at the lower of cost and net realizable value.
Precious metals that are related to the Group’s trading activities
including precious metals lease and [precious metals] interbank lending are
initially and subsequently recognized at fair value, with changes in fair
value arising from re-measurement recognized directly in profit or loss in
the period in which they arise.
Apparently, the Bank Of Communications has its gold
leasing business disclosed on its balance sheet in the precious metals
category.
Below is from the 2015 annual
report of Shanghai Pudong Development Bank (page 17):
Translated:
As the main cause for the growth in precious metals is considered to
be “increased physical gold leases”, we must conclude in the
case of Shanghai Pudong Development Bank nearly all precious metals on its
balance sheet relate to gold leasing. But does this mean Chinese banks
buy gold on the SGE and then lease it out? Not necessarily.
Chinese banks mainly do back-to-back gold leasing. Banks
don’t have much money of their own. They need to borrow money or gold either
from savers or in the interbank market to subsequently make loans. Would it
make sense for banks to borrow money in order to buy gold to subsequently
lend out gold? Or would it be more logic for banks to borrow gold to
subsequently lend out gold?
From
a source who worked at the precious metals trading desk at ICBC in 2014 I was
told first hand ICBC has little gold of itself for leasing, most of the
gold lend out is borrowed from third parties. These third parties
are mostly SGE members or overseas banks that lend gold through the
Chinese OTC market. All
commercial bank gold leasing is settled through the SGE.
ICBC operates in the lease market as an intermediary by connecting
supply (lessors) and demand (lessees). ICBC can borrow gold from
international banks or local gold owners with an SGE Bullion Account, and
lend the gold to miners, jewelers or speculators. My assumption
is that the international gold lease rate is lower than the Chinese gold
lease rate, which attracts gold from the international market into the
Chinese domestic gold market. (Whenever a gold loan is to be repaid from
the Chinese domestic gold market to an international lender, not the physical
metal is exported, but funds cross the Chinese border, as physical gold
export is prohibited from the Chinese domestic gold market.)
Also note, if banks would buy gold to lend out, they are exposed to the
price risk of gold. In order to cover this risk, banks need to hedge but this
will involve additional costs. As a result, the logical solution is
for banks to do back-to-back gold leasing.
Bank of Beijing is a good example to illustrate back-to-back gold
lending. Unlike other Chinese banks, Bank of Beijing does
not put gold leasing in the precious metals category. It has a separate line
in its books for gold leasing.
According to the 2015 annual
report of Bank of Beijing (page 123, 132):
Exhibit 3.2. “Leased in” is
borrowing. The unit is RMB million.
As readers can see from the excerpts above, Bank of Beijing indeed
does back-to-back gold leasing as precious metals “leased in” are equal to
precious metals “leased out”. I suspect most gold leasing by Chinese banks is
back-to back gold leasing.
Because Bank of Beijing has its leasing business noted in a
separated line than its “precious metals”, we can see a huge discrepancy
between Bank of Beijing’s precious metals holdings in exhibit 1 (RMB
55,000,000) and its back-to back leasing business in exhibit 3 (RMB
1,400,000,000).
Other banks don’t have a separate line for the gold leased out but
as mentioned before, they put it in the precious metals category. A
widely-accepted method to treat borrowed gold is to include a liability
called “financial liability at fair value through profit and loss”. Readers
who can understand Chinese are recommended to click this and this
link. The ICBC annual
report provides an example of how the liability is recorded.
In conclusion, back-to-back gold leasing will result as an asset
(precious metals) and a liability (financial liability at fair value through
profit and loss), for most banks highly inflating the precious metals
category. When looking at exhibit 4 we can see the enormous growth in
yearly Chinese gold leasing turnover, which must
have enlarged Chinese banks’ balance sheets.
4. Hedging
China’s commercial banks offer derivatives to retail and institutional
customers. Bank of China’s Qi
Jin Bao is an example. Qi Jin Bao is in fact gold option business. The
retail customer pays a certain amount of money (option premium) and buys a
gold call option or put option.
For example (simplified): suppose the current gold price is $1300/oz
and a retail customer is bullish on gold and believes that the gold price
will rise in 3 months time. Therefore, the retail customer buys a 3 months
call option with a notional amount of 100 oz of gold at the strike price of
$1300/oz from Bank of China and pays an option premium of $35/oz. If the gold
price indeed goes up in 3 month’s time, the retail customer will make money.
However, derivatives are a zero-sum game. If the retail customer makes money,
then the Bank of China definitely loses money. If the gold price goes up to
$2000/oz, Bank of China will lose big time. In order to mitigate this risk,
Bank of China will (borrow money to) buy gold to hedge the short call
position and the gold purchased will appear on the balance sheet.
Gold on the balance sheets of Chinese commercial banks doesn’t necessarily
have to be gold held in China. Chinese banks like ICBC, BOC and Bank of
Communications have direct access to the LBMA. As a result, gold on the
balance sheets of Chinese commercial banks can be located outside China
mainland.
Conclusion
From the descriptions above, the precious metals holdings on the balance
sheets of Chinese commercial banks are far more complicated than the
“everything is gold leasing” assumption. In order for us to learn more
exactly what the precious metals on the balance sheets represent we
need more information, more investigation is needed by gold
analysts. Hopefully this blogpost can serve as a springboard to a better
collective understanding.
Addendum
In addition to Gold Accumulation Plans many Chinese banks offer a variety
of (paper) gold hedging and speculation broker services to their clients. For
example, in the annual
report 2014 from Agricultural Bank of China (ABC) we can read:
… Precious metals
… As a major precious metal market maker in the PRC, the Bank
provided customers with precious metal trading, investment and hedging
services through … trading of precious metal derivatives … and trading
… the Shanghai Futures Exchange and the London precious metals market.
So, through ABC clients can trade paper gold, but these
derivatives would be recorded off-balance sheet,
or in a separate line next to “precious metals”. More
from the ABC annual report 2014:
Our off-balance sheet items primarily include derivative financial
instruments, contingent liabilities and commitments. We enter into
currency rate, interest rate and precious metals related derivative financial
instruments for the purposes of trading, asset and liability management and
business on behalf of customer.
Implying, from my judgement, all the precious metals
on-balance sheet are not (customers’) paper gold.