Moody's says BOC and CCB lack adequate business models to defend against liberalisation of the sector
Bank of China (BOC) and China Construction Bank (CCB) have yet to develop business models strong enough to cope with rising competition and declining state support, despite recent reforms, according to ratings agency Moody's.
Monetary tightening measures designed to cool economic overheating may further slow reform in the state banking sector.
'Overall, Moody's believes China's banking reform efforts have been positive and substantial,' the agency said in a report released yesterday.
'However, it will still be some time before the major state-owned commercial banks, such as BOC and CCB, can develop defensible business models with sustainable earnings against an evolving backdrop of greater competition, further market opening, and weaker anticipated government support.'
Pressed by an end-2006 deadline to fully open the sector to foreign competition, Beijing last year injected US$22.5 billion into each of CCB and BOC, unveiling a pilot programme to revamp the Big Four state-owned commercial banks.
The state also financed the sale of 278.7 billion yuan of non-performing loans (NPLs) from the two lenders to an asset management firm, following a similar transfer of 1.4 trillion yuan in NPLs in 1999.
Although corporate governance reforms have begun at the two banks, Moody's questioned whether their newly installed boards could function as intended. Management may only gradually become used to the new decision-making methods, and there is a dearth of independent and experienced outside directors in China.
The appointment of senior managers will remain opaque. The amount of senior foreign talent recruited may be limited and unlikely to yield immediate results.
Domestic interest-rate regime reforms and business cycles may also go against the Big Four.
In October, Beijing scrapped the ceilings on lending rates and allowed banks to set their own deposit rates for the first time.
The reform will enable smaller, more flexible shareholding banks and foreign lenders to make headway, especially in the newer and more profitable consumer businesses, while introducing earnings volatility at the Big Four.
Attempts by the banks to become price leaders using their funding advantage could worsen their asset quality down the road.
NPLs as a percentage of outstanding loans have fallen drastically to 5.16 per cent at BOC and 3.74 per cent at CCB.
However, Moody's credited much of the improvement to rapid loan growth for 2002 and last year and direct government support for NPL disposals and write-offs.
'If loan growth slows, as anticipated, it will become more difficult to achieve rapid reductions in NPL ratios,' Moody's said.
Such concerns may well become reality after recent administrative efforts to cool overheated sectors such as cement, steel, aluminium, car and real estate, including the first rise in central bank benchmark rates in nine years.
The policy changes may reduce loan demand and erode lending profits, reducing the funds available for banks to build up their loan-loss reserves.