Ukraine crisis has made China’s economy dependent on Japan’s banks

With dollar liquidity in Asia likely to become tighter amid the Ukraine crisis and China’s banking system remaining domestically focused, Japan’s megabanks in financing Asia’s economy will be a critical factor in ensuring free flow of dollars in the region, reported Nikkei Asia.

As per an opinion piece written by Andrew Hunt and Ben Ashby in Nikkei Asia, with China’s banks lacking the creditworthiness and international connections that Japan’s financial institutions enjoy, financing of Asia’s trade will be heavily dependent on Japan.

Notably, having a very large deposit base but limited domestic demand for credit since the 1990s, Japan’s big banks were compelled to look for profits in international capital markets, which are dominated by dollars.

Further, being a close ally of the US, Japan has an added advantage as compared to China, that is, it can borrow dollars directly from the US Federal Reserve to provide a temporary overdraft to its banks.

However, the People’s Bank of China and even the Hong Kong Monetary Authority rely on a finite amount of US currency reserves, the access to which depends on the goodwill of G7 nations, according to the opinion piece.

But with the US Federal Reserve likely to tighten global liquidity amid worries concerning inflation, Japanese banks will have to take tough decisions over what to do with the more than USD 5 trillion worth of overseas claims they have amassed.

Japan now face the dilemma regarding its next step, which is, if it should cut back on risk and reduce its Eurodollar borrowing, charge a higher interest rate to borrowers, or become more selective in its lending.

However, with USD 166 billion of direct exposure to mainland China and Hong Kong, and huge problems beginning to surface in Chinese real estate, the sector will become the prime candidate for risk reduction, Nikkei Asia reported.

It is going to be a difficult balancing act for Tokyo’s bankers, who if do not pull it off, may add to China’s own problems at an already difficult time.