China’s borrowers turn to bonds

CHINA’S vast bond market is taking on an increasingly important role in financing the economy, offering policymakers a new way to lower borrowing costs at a time when traditional bank lending is losing momentum.

According to a Bloomberg report, bonds have become an increasingly prominent source of credit for Chinese companies and governments, reflecting both structural changes in the economy and the central bank’s efforts to support growth without putting additional pressure on banks.

Official data show bond financing, including government and corporate debt, accounted for 30% of China’s outstanding credit stock in May, the highest proportion on record.

More significantly, bonds overtook loans as a source of new credit in 2025 for the first time, albeit by a relatively modest margin of around 500 billion yuan (US$74bil).

Economists expect that gap to widen further over the remainder of the year.

The shift comes as Chinese authorities face a difficult balancing act. Economic growth remains under pressure from weak domestic demand, sluggish consumer spending and soft investment activity.

Yet, the People’s Bank of China (PBoC) has been cautious about aggressively cutting benchmark lending rates because of concerns about the health of the country’s banking sector.

Chinese banks have endured years of shrinking profitability as lending rates have fallen faster than funding costs.

Net interest margins, a key measure of banking profitability, fell to a record low of 1.4% in the first quarter. For comparison, net interest margins in the US banking sector remain comfortably above 3%.

Against that backdrop, Bloomberg report that policymakers have increasingly relied on the bond market to transmit easier financial conditions throughout the economy.

Injecting liquidity

Rather than aggressively lowering lending benchmarks, the PBoC has spent much of the year injecting liquidity through open-market operations while allowing the rate on one of its policy lending facilities to fall to a record low.

The additional liquidity, combined with weak demand for new loans, has encouraged commercial banks to increase their bond holdings.

As China’s largest bond investors, banks have played a central role in driving bond prices higher and yields lower.

The decline in yields has effectively reduced borrowing costs across the economy, providing support to businesses and local governments seeking financing.

Ding Shuang, chief economist for Greater China and North Asia at Standard Chartered, tells Bloomberg that the central bank’s strategy had created an alternative route for easing financial conditions.

“It’s lowered bond yields through market rates, which led to greater demand for bond financing,” he says. “It provides a way to lower overall financing costs when loan rates are constrained.”

The growing importance of bond financing was publicly acknowledged by PBoC governor Pan Gongsheng during the recent Lujiazui Forum in Shanghai.

Pan describes the slowing pace of loan growth and the rising role of bond and equity financing as evidence of a “profound adjustment” in China’s economic structure.

As the country shifts away from a growth model driven by property development and infrastructure spending towards one centred on advanced manufacturing and technology industries, the composition of financing is changing as well.

The central bank appears increasingly willing to embrace that transition.

Bloomberg notes that official messaging has become noticeably more focused on the role of capital markets in supporting economic activity.

Earlier this month, Financial News, a newspaper affiliated with the PBoC, described bond financing as an “important channel” influencing money supply and credit creation.

That language echoed comments made in the central bank’s quarterly monetary policy report released in May, which included a dedicated section examining the growing importance of the bond market.

Part of the increase in bond issuance stems from Beijing’s ongoing campaign to tackle local government debt risks.

Late last year, policymakers launched a 10 trillion yuan programme aimed at replacing off-balance-sheet borrowing by local governments with more transparent bond financing.

Some estimates suggest that around 60% of that hidden debt had previously been funded through bank loans.

The programme has triggered a surge in government bond issuance, which now accounts for the largest share of China’s bond financing activity.

However, the attraction of bonds extends beyond government debt restructuring.

Cheaper funding

For many borrowers, the bond market simply offers cheaper funding.

Yields on five-year AAA-rated corporate bonds denominated in the yuan have fallen below 1.8%, down from 2.13% roughly nine months ago. Five-year government bond yields have also declined, falling to around 1.5% from 1.7% at the start of the year.

Those rates compare favourably with traditional bank borrowings. China’s five-year loan prime rate currently stands at 3.5%, while the average corporate loan rate is around 3.1%.

The cost advantage has translated into growing demand.

Bloomberg reports that new corporate bond financing increased by 1.7 trillion yuan during the first five months of 2025, more than 80% higher than during the same period last year.

New bank lending, meanwhile, declined by 11%.

For years, economists have argued that China should rely less heavily on banks and develop deeper capital markets.

Bond financing is generally viewed as more transparent, provides access to a broader investor base and can improve the allocation of capital throughout the economy.

Yet, some analysts caution that cheaper financing alone may not solve China’s current economic challenges.

The bigger issue, they argue, is weak demand for borrowing.

Businesses remain cautious about expansion plans, while households continue to hold back on spending despite various stimulus measures.

Even so, the growing dominance of bond financing is beginning to influence expectations for monetary policy.

Bloomberg reports that economists at Nomura recently delayed their forecasts for further cuts to the PBoC’s policy rate and banks’ reserve requirement ratio until 2027.

Their reasoning is straightforward: abundant market liquidity and falling government bond yields are already delivering many of the effects that traditional monetary easing would normally seek to achieve.