Banking & Finance

Chinese banks’ bad loans are improving, but everything else is getting worse

Liquidity, solvency and profitability all a worry for banks say analysts, with smaller banks struggling in particular

PUBLISHED : Tuesday, 12 December, 2017, 5:02pm
UPDATED : Wednesday, 13 December, 2017, 12:28am

The biggest problems for Chinese banks are starting to shift from worries about bad debt to other concerns, say analysts.

“Asset quality is improving, but this is the one and only improvement in Chinese banks’ situation,” Alicia Garcia Herrero, chief economist Asia-Pacific at Natixis, said at the launch of the investment bank’s “China banking monitor”.

Garcia Herrero said that Chinese banks’ problems with liquidity, solvency and profitability were all deteriorating.

Liquidity – banks’ access to short term cash to meet their obligations – is particularly a problem for mid tier and smaller Chinese lenders that do not have access to the vast deposit bases of their larger competitors.

These banks need easily accessible cash to fund their lending and investments, and are forced to look to increasingly unstable and costly sources to obtain it, such as borrowing directly from the interbank market, issuing further wealth management products, negotiable certificates of deposit and short term debt instruments.

China bans new deposit certificates, tightening screws on interbank lending to curb risks

The problem is that regulators, concerned about mismatches between banks lending or investing over long durations and borrowing over short, have looked to crack down on each source of funds in turn, in what Natixis analysts describe as a game of regulatory cat and mouse. This is driving the banks to look to newer, even less stable and more costly sources to fund their day to day activities.

In addition, smaller banks in China are not only facing problems with their short term liquidity, but potentially also with their overall solvency.

Last week, the International Monetary Fund published the results of a stress test, which looked at the performance of China’s banking sector. It found that 27 out of the 33 Chinese banks it assessed would not meet capital requirements in the event of a major shock. The six banks that did meet the requirements included all of China’s big four banks – ICBC, Agricultural Bank of China, China Construction Bank, and Bank of China.

The IMF urged a gradual and targeted increase in bank capital to resolve the issues.

The banks will have to raise this capital from the market as they are not adding to their capital buffers organically, through greater profits.

This year, Chinese banks’ overall net profits have been rising, but they have been rising because the banks have lent and invested more rather than having done so more efficiently.

This means they need even more capital to cover potential losses.

Chinese banks’ return on assets fell from 1.1 per cent in 2015 to 0.91 per cent in 2017, according to the Natixis economists’ calculations.

Big still means better for Chinese banking sector in first half

Struggles with profitability are set to continue.

“[Banks’] overall profitability will remain constrained by continued net interest margin pressure. Growth in net fees and commissions income will also slow on stricter regulations on shadow banking,” wrote analysts at Moody’s Investors Service in their outlook for Chinese financial institutions, published on Tuesday.

Nonetheless, mainland banks can still look at the improvement in their asset quality as an achievement. Chinese banks’ stressed loan ratio has dropped from 5.61 per cent at the end of last year to 5.3 per cent in the third quarter of this year, according to Natixis’ calculations.

Stressed loans are those banks count as non performing and so-called special mention loans which they flag but do not describe as non performing.

This improvement in asset quality should continue into next year.

“Overall delinquencies will stabilise on the back of continued economic growth, improving corporate profit and steady commodity prices,” wrote the Moody’s analysts.