Banking & Finance

The China small bank syndrome: aggressive and unable to say no

New yuan loans fell 51 per cent to 513.6 billion yuan in October

PUBLISHED : Sunday, 15 November, 2015, 2:28pm
UPDATED : Sunday, 15 November, 2015, 2:27pm

A credit crunch has set in on the mainland, with big state-owned banks pulling in lending sharply to meet year-end targets while figures still stay high at the smaller second-tier joint stock banks and third-tier regional and city banks.

New yuan loans declined sharply to 513.6 billion yuan in October, from 1.05 trillion yuan in September. The 51 per cent decline was much bigger than analysts had expected, with earlier estimates for new loans in October hovering around the 800 billion yuan mark.

National state-owned banks, joint stock banks and city commercial banks are under pressure to meet the China Banking Regulatory Commission’s assigned common equity tier-one (CET-1) ratios this year. Plenty have been to trying for years to bolster capital via listings and, since last year at the CBRC’s urging, additional rights issues.

But even as they need capital, smaller banks have been criticised by banking analysts for sometimes being too aggressive in their lending outlook. As a leading equity syndicate banker who has been working closely with the banks in raising capital in Hong Kong explained: “the regional and local banks – they are so ingrained to the local economy – they really can’t say no.”

While local bankers may have the advantage of knowing the local economy better and capturing local growth better, possibly helping them stay out of bad debt troubles, the IPO banker is sceptical.

In their risk profile, there is no diversification. I don’t know what their rating policy is
IPO banker

Unlike the state-owned banks, which had portfolios spread across the country, the regional and local banks were more likely to be under the thumb of local officials who worked to fit banks into their economic goals, he said.

“With business models focused on small to medium-sized enterprises, maybe you have two or three big corporates in your region, it’s a very different profile from state-owned banks,” the banker said. “In their risk profile, there is no diversification. I don’t know what their rating policy is.”

Auditors answer carefully when asked to what extent balance sheets reflect asset quality at the smaller banks that are trying to raise new capital.

There will be more clarity on asset quality when listed banks on the mainland comply with the new, ninth edition of the International Financial Reporting Standards, IFRS 9. Keith Pogson, a senior partner at Ernst & Young, said banks would have to move from the current backward-looking incurred loss model to include an “expected credit loss model” that would look more holistically across businesses for potential credit loss events .

It was because of their high visibility that big state-owned banks were further ahead in reining in lending and aligning themselves with new capital and accounting standards than their smaller peers, Pogson added.

Eddy Wong, partner for capital markets services at PWC Hong Kong, said governance and internal controls would improve due to market discipline as more banks got listed.

But the IPO banker said smaller mainland banks deserved a big discount.

“You have to trust them and their policies. They would be much more willing to bend the rules,” the banker said. “... Chinese banks, especially the smaller ones, I’d always give them a big discount.”

This may be why smaller banks struggle to go to market and price efficiently. Institutional investors in Hong Kong often struggle to justify valuations for small mainland banks. Several have tried to list in Hong Kong, but were rebuffed.

“They can’t price efficiently – they can only price at one time to book, even if they are only worth 0.6x,” the banker added. But even that had been deemed “expensive”, making them tough to sell to clients.