Chinese banks feeling the heat

Following on from last night’s post on S&P’s recent report on China and commodities, the Royal Bank of Scotland (RBS) yesterday released an interest report (available below) on the precarious position of the Chinese banking system.

Here are some key extracts:

Chinese banks’ aggressive credit expansion in the past two years greatly facilitated China’s strong economic recovery during the global financial crisis. Since the beginning of 2009 until now, total loans at Chinese banks grew by 65%. In other words, close to 40% of their total loans were lent out in the past two and a half years, especially in 2009 when the world was in a financial crisis. China’s financial system is highly leveraged with the ratio of bank loans to GDP already hitting 120%, higher than the peak level of Japan during its financial bubble. This ratio could be even higher if offbalance sheet loans are factored in…

In addition to LGFV loans, loans to the buoyant property sector could also be a concern. These include loans classified as property loans, which are about 20% of Chinese banks’ loan book, as well as loans that were lent out as corporate loans but subsequently channelled into the property sector. Also, some of the LGFV loans possibly went to the property developers as well.

Moreover, off-balance sheet lending has become another issue since 2010 when the government tried to put a brake on lending, especially on loans to the property sector and LGFVs. The rapid growth of off-balance sheet financing, such as entrusted loans, trust loans and bill acceptance, has added more worry to the already questionable balance sheet of Chinese banks…

Given the current situation of their asset quality and capital base, we think that Chinese banks will have difficulty in sustaining their past loan growth. This will have a significant impact on its macro economy because Chinese banking lending, including on-balance sheet and off-balance, has big implications for China’s economic growth. 

People argue that the reliance of the economy on bank lending has declined significantly in recent years, as evidenced by the fact the economy kept growing even after bank loan growth started to come down in 2010. However, we noticed that although bank RMB lending has slowed, other forms of financing have not slowed down…

China’s high economic growth can hide much of the asset quality and capital problems at the banks. However, if growth comes down, the banks will be left facing serious issues. Moreover, with potential asset quality and capital problems, it will be difficult for the banks to keep providing financing to the economy at their current pace over the medium term…

Many may argue that this is not a serious issue because the Chinese government can easily recapitalize the banks just like it did before the big banks had their IPOs. However, we do not think that it will be so easy the second time around. Previously when the government recapitalized the banks, it owned 100% of their shares and therefore there was no question about the government footing the bill for non-performing loans. Now, however, Chinese banks are the largest banks in the world in terms of market cap, and it will not be easy for the government to foot the bill without sharing the burden with shareholders. Moreover, given China’s high loan-to-GDP ratio, cleaning up the banks would be much more costly than before. Finally, the process of re-capitalization would be painful and would likely affect the banks’ role of supporting China’s economic growth in the meantime.

Leith van Onselen

Leith van Onselen is Chief Economist at the MB Fund and MB Super. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.

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Comments

  1. So what? Given that virtually all western governments recapitalised the private banking system by taxpayers money, why can’t the Chinese do the same? What is the difference?

    Oh yeas, the Chinese government does not need to finance itself by borrowing on international money markets, it has deep reserves to re-capitalize the banks.

    • The belief in Chinese triumphalism is even more deep-seated than the belief in Japanese triumphalism in 1989.

    • Whatever, China’s fiscal position isn’t even that healthy. The central governments debt is officially about 20% of GDP and its estimated that the combined local governments debt to GDP ratio stands at around 40%. Add in NPL and other losses which the Chinese taxpayer will probably have to bear and the debt to GDP ratio could easily be around 100% (a lot for a developing economy). So no they do not have deep reserves.

    • Read M Pettis on why USD reserves cannot be used to recapitalise internal loan defaults.

      Cost of defaults to be borne by public via suppressed interest rates.

      This suppresses consumption and long term economic growth.

  2. Leith,

    “Whatever” beat me to it, but I was about to say…

    I think you’ll find China is different. China has a lot of people you know, and China is very early along the path to industrialisation. The Chinese authorities simply won’t let a crash happen, and besides they have a huge stash of foreign reserves that will fix any banking crisis (BTW, I think they need that to keep a lid on the RMB)

    Indeed, China will simply magic away the trillions in bad debt for building stuff they don’t need. How? Because they are China.

    Its simple really. China won’t crash, because China is China.

    • Actually centrally planned = kicking the can down the road longer = bigger crash when it comes.

      It’ll all be rosy until it isn’t. That’s why conventional economists will be fooled by PMI figures, employment stats, confidence measures etc..

      Just like the RBA and our Treasury just assuming that Chinese industrialisation will drive the mining boom.

      A cursory look at debt and Chinese commodity consumption should have rung the alarm bells.

      If China is so good at central planning, my question is: why did they lend out so much money in 09, 10 and 11?

      So you see, there are no quick exits.

  3. No, China’s economy can crash like all other economies. But it will be driven by its social and political dynamics not by its ‘banking sector’.

    • …I guess one could ask why there would be social and political issues in such a totalitarian state?

      Oppression and suppression? Sure, plenty of that…

      …but what about welath transfer and inflation?

      They are some banking (and govt) related issues to consider.

      Hence, very likely banking-root-cause contribution, and probably a significant contribution.

      eg. you make my food inflate, i will revolt…