If you can recall, some time ago I talked about the CBRC’s annual report on the Chinese banking system. The report said that Chinese banks are very well capitalised, with non-performing loans falling every year and capital adequacy ratio rising every year.
You could have guessed that I disagree. As I have talked about previously, China simply has much more debt than anyone can imagine, and banks were lending aggressively and indiscriminately to serve the state’s objective of whatever GDP the government was targeting. Simply look at the size of total banking assets and money supply, you know that debts are high. And because much of this debt is used to fuel the real estate bubble, as well as finance pointless and/or financially ruinous projects like the high-speed rail to nowhere, a big part of the debt is bound to go bad. The non-performing loans (NPLs) number on the official report (0.96%) is impossibly low. Already, real estate companies are all finding it difficult to service there debt, while the Ministry of Railways is apparently losing money.
Last year, Credit Suisse estimated that the true NPL ratios would be 8-12% and that could wipe out quite a bit of banks’ equity capital. That view is echoed by Charlene Chu of Fitch rating, who is quoted in The Economist that “if a tenth of the banking system’s outstanding credit turns sour over the next two years, all profits and 39% of the system’s equity will be wiped out”. The Economist’s story went on to say “The Chinese banking system is already among the most thinly capitalised in emerging markets (the ratio of equity to assets is 6%)”.
The blog Sober Look, also has a good take on the same article from The Economist:
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What’s more, banks were the biggest drivers of earnings growth, totaling 56% of all A-share revenue increases in Q1. And that could point to a broader problem.
The Economist: – The seven biggest mainland banks have just posted a 16% year-on-year increase in pre-tax profits between them for the first quarter. The level of non-performing loans (NPLs) remains low, at just about 1%. But trouble is being stored up for the future.
There are two big worries: bad local-government debt and souring property loans. The infrastructure binge of the past few years saw a boom in local-government financing vehicles (LGFVs), off-balance-sheet entities used to get around prohibitions on borrowing. Regulators say these entities’ bank debts were worth $1.4 trillion at the end of September. Private estimates range much higher, and suggest that 20-30% may be non-performing.
Not only have many bad loans been shifted to off-balance-sheet entities, but the government has been actively moving bad assets over to the so-called “policy banks”.
The Economist: – Another wheeze is shoving these loans onto the books of “policy banks” like China Development Bank (CDB), whose balance-sheets are now suffering. Half a trillion yuan, around $80 billion, in LGFV debt was rolled over last year from commercial banks to the CDB alone.
CNBC: – “Frankly, our banks make profits far too easily. Why? Because a small number of major banks occupy a monopoly position, meaning one can only go to them for loans and capital,” China National Radio quoted Wen as telling local businesses at a roundtable discussion.China is clearly concerned about this state sponsored profitability at banks and the perception it creates – both domestically and internationally.
“That’s why right now, as we’re dealing with the issue of getting private capital into the finance sector, essentially, that means we have to break up their monopoly,” the radio news service reported Wen as saying on its website.
It is clear that this profitability in the banking sector is completely artificial, as bad loans have been “hidden” away. And that in turn raises questions about the profitability growth for the overall domestic equity markets in China as well as the rising risks in the “hidden” banking system.
