Banking & Finance

On borrowed time

China’s banking sector braces for the impact of another round of stimulus

ICBC-w

Banks released results this week, but worsening NPLs look likely

Despite a battle of their own with mounting bad debt and poor profitability in recent years, China’s banks have been given another onerous task: helping to soften the economic shock from Covid-19.

The country’s lenders were asked to tolerate a higher share of soured loans when the virus started raging across the economy two months ago (see WiC483). But as the threat to growth has started to shift from disruption in domestic production to a collapse in overseas demand, the banks are now being charged with accelerating their lending in a bid to keep local companies afloat.

We reported in WiC488 that 25 provinces and big cities had outlined commitments to backing 220,000 infrastructure projects that could eventually be worth as much as Rmb50 trillion ($7.05 trillion). No doubt the banks will have a role to play in buying the bonds bolstering the infrastructure push. But they’re also expected to meet the more immediate needs of many of the country’s smaller and mid-sized firms, who are crying out for emergency loans.

Hence the PBoC is freeing up more cash among the commercial banks by implementing targeted cuts in their required reserve ratios (RRRs). Early this week it also injected Rmb50 billion into money markets through seven-day reverse repos, and reduced the seven-day reverse repos rate (an interest rate on loans to banks) by the largest margin in five years to 2.2%.

Economists are expecting the PBoC to guide down corporate borrowing costs further by lowering medium-term lending rates (which influence the costs of longer-term loans), as well as bringing down the loan prime rate (the benchmark against which banks charge their most creditworthy clients preferentially).

Of course, action like this is going to pressure net interest margins – a key driver of banks’ profitability. The cheaper lending also comes at a time when some of the banks were already looking snowed-under with Rmb2.41 trillion of bad debt, an overhang partially rooted in the Rmb4 trillion stimulus package rolled out in response to the 2008 global financial crisis.

While the share of bad debt at the end of last year represented just 1.98% of their total loans, a more inclusive estimate of the situation by S&P Global, a credit rating agency, has suggested that up to 13% of the loans in the commercial banking system could become “questionable” – either soured or overdue – in the aftermath of the coronavirus outbreak.

That begs the question of whether the banks are strong enough to support another round of stimulus in the way that the authorities envisage.

In the last three years, the five largest banks have managed to improve their NPL ratios, largely though aggressive asset disposals. ICBC, for instance, saw its proportion of bad debt fall from 1.62% in 2016 to 1.43% last year, after writing off Rmb97.6 billion of soured loans. That sum is roughly eight times the amount it wrote off a decade ago, and bigger than the bank’s entire impaired loan balance at the time.

Agricultural Bank of China, after resolving Rmb51.4 billion of bad debt, also recorded a substantial decline in its NPL ratio from 2.37% to 1.4% in the same period.

But the pace of the clean-up of soured loans is lagging that of the creation of newly toxic assets, as suggested by the substantial increase in loan-loss provision among the main lenders. Totalling Rmb1.35 trillion last year – roughly the size of the Algerian economy – this item has more than doubled in size on bank balance sheets in a decade.

Aside from restraining the capacity to lend, the provision is also eating into the banks’ shareholder equity. Although net profits have returned to growth, return on equity has fallen to the low teens from the higher teens a decade ago.

This week the big five banks reported “estimate-beating fourth quarters”, according to Reuters, contributing to annual profit growth of 4-5% in 2019 “due in part to improving asset quality”.

But the Chinese banks’ Hong Kong-listed shares have been trading below book value for years. Bank of Communications, whose shares are down 16% year- to-date, has the lowest price-to-book ratio of 0.46. Downtrodden valuations in general mean that many of the banks will have less flexibility to raise funds in future, because of rules that forbid them from selling equity at below book value.

More positively, most of the banks have decent capital buffers, with China Construction Bank enjoying the highest common equity tier-one (CET1) ratio of 13.9% as at the end of last year.

Smaller banks look more vulnerable, however. Credit rating agency Fitch believes the likes of China Minsheng Bank, Huaxia Bank and China Guangfa Bank will see their CET1 ratios fall below the minimum regulatory requirement of 7.5%, while a number of mid-sized peers will see their ratios skid close to the threshold, because of exposure to sectors such as manufacturing, wholesale trading and retail, which are heavily affected by the coronavirus outbreak.

“Ultimately it’s still the mid- and small-sized banks that will see the biggest hit to their asset quality,” warns Grace Wu, head of greater China banks at Fitch.

Taking a similar view, Moody’s downgraded the outlook for six mid-tier banks to negative from stable on concerns about their deteriorating credit quality. Among them: Bank of Nanjing and Bank of Ningbo.

“Currently, Covid-19 is continuing to cause damage to people all over the world and affect the global economy and the financial markets. In 2020, the domestic banking industry will face an even more severe and unfavourable environment for development, as well as more challenges and difficulties in operation,” Guo Zhiwen, chairman of Harbin Bank, wrote in its latest earnings report.

Bailed out by the state last year (see WiC475), the lender reported a 36% dive in net profits for 2019 on a 114% jump in impairment losses. Aside from recapitalisation, it will likely have to accelerate its debt collection and recovery business.


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