Banking & Finance

All black

China’s banks remain bastions of profitability in a world of red ink

All black

Coasting along, for now...

Given the modest amount of their own capital and their tiny loan-loss reserves, and after taking into account the magnitude of non-performing loans, several of China’s major banks are already insolvent.”

This was the verdict – almost exactly a decade ago – that the Brookings Institution’s Nicholas Lardy came to in his book China’s Unfinished Economic Revolution.

How different things look 10 years on. Lardy’s statement could now be applied to any number of European and American banks. The Chinese banks, on the other hand, have just released results which – on the contrary – show relatively strong profits.

On Tuesday, Bank of China announced its 2008 profit grew by 14%. Admittedly it was its slowest rate of growth in three years, but it still racked up profit of Rmb63.36 billion ($9.4 billion). ICBC announced a 36% rise in profits to $16 billion; making it the most profitable bank in the world. Compare that with Citigroup’s $32.1 billion loss in 2008; or the $18 billion avalanche of red ink posted by UBS.

It is a remarkable transformation. When Lardy penned his book, the Chinese banks did indeed look to be in a lamentable state. Lardy pointed out that they were serving a social function, as much as an economic one – by making crazy loans to state-owned enterprises merely to keep them afloat, and with little or no hope of being paid back.

After a major clean-up, and some high profile IPOs, the big Chinese banks have been continuously profitable in the ensuing period. The foreign banks that invested in them – such as RBS and Bank of America – have since sold some or all of their stakes. And in a mark of how topsy turvy the world has become, it is Bank of China and China Construction Bank (CCB) that could buy RBS and Bank of America, and not the other way round.

But as to making foreign acquisitions, they are playing it coy. Guo Shuqing, who heads CCB said earlier this month: “The global financial crisis is far from over and lots of things are still uncertain. We will not make hasty decisions on overseas acquisitions under such circumstances.”

In a wide-ranging interview with the China Daily, his counterpart at Bank of China struck a similarly prudent tone while remaining open to foreign expansion. “The bank will be very cautious when making decisions on overseas acquisitions, but it has to accelerate its expansion into overseas market,” said Xiao Gang, the Bank of China chairman. “The global financial crisis has given Chinese lenders a great opportunity to grow.” Then again, the bigger growth opportunity is probably at home. CCB extended Rmb256 billion of new loans in January, with half going to China’s new infrastructure projects, according to the bank.

But with the economy having shed jobs and exports slumping, the picture for the Chinese banks is by no means a sunny one. The country’s fifth largest bank, the Bank of Communications predicted a tough year ahead. Indeed, while its fourth quarter profits comfortably beat analyst estimates, it warned that higher non-performing loans and tighter interest margins would make the business climate more challenging in 2009. It increased its provision coverage ratio to 166%.

China’s bank regulator is aware of the problem of a growing portfolio of non-performing loans. It has ordered the big three state-owned banks to up their provision coverage ratio to 150%, from the current average of around 120%.

“I would say it is possible for large amounts of non-performing loans to emerge,” admits BOC’s Xiao. “But the way domestic banks do business is different from five years ago. Take BOC, for example. A centralised loan approval process has reduced the chances for bad loans to occur.”

He notes that BOC’s ratio of impaired loans was reduced in 2008 from 3.17% to 2.76%.

But with loan growth surging in support of the government’s stimulus package, most analysts concur that an increase in NPLs looks almost inevitable.

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