China’s unbelievable banks

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:

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.

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Comments

  1. YAY! I should get some unsecured loans from Chinese banks while I can – I’ve had my eye on a Maserati for some time and I think a Chinese Bank could have the answer I’m looking for…

    Seriously though, isn’t anyone in our government worried about the precarious situation that Chinese ‘capitalism’ is in given our almost exclusive reliance on their continued success?

    • Nope. Ever since Ken Henry declared “the GFC is over” and that we are set for “a period of unprecedented prosperity” thanks to a mining boom that will last “for several more decades into 2050”, it has been an article of faith.

      The gods have spoken.

      • I remember that. That was when Treasury and the RBA were forecasting 4% growth for as far as the eye could see. They looked great on paper — all those 4’s.

  2. Explains why we have cardigan wearing clients who look like they run a market vegetable stall bringing in $10million+ to finance developments.

    Its no suprise that there is still quite alot of asians buying up in the market. Regardless of price falls, the important thing is that they have managed to get the cash out of China.

    • Value VoodooMEMBER

      Christiaan, you don’t understand how the Chinese people operate. For a salesperson in a bank or a jewelry store, they target those cardigan wearing customers wearing slippers because they know those are self-made millionaires. They have lots of money. Whereas someone who walks in with a sharp suit on, he is probably just an employee working for a firm owned by someone who wears slippers.

  3. The dependecy of the Australian economy on China means that Australia will have not Japanese style soft landing. As china retracts the Australian economy will catapulted towards the ground.

      • I agree – but with limitations. Speed kills according to the police, and they should know.

      • Aristophrenia

        The blog you’ve referenced is pretty thin, anything that starts off with the cash reserves of the Chinese as a basis for their argument has pretty much no idea whats going on – its complete rubbish.

        Secondly the shift to consumerism is another massive furphy which has been discredited a million times – stopped reading, its crap.

        • Lol. I’ve noticed you like issuing instructions. Are you stuck in a back office somewhere?

          FWIW I came to that blog via recommendation at Deflationite – a well regarded site I would imagine.

          You don’t know it all my friend. 🙂

          • Aristo doesn’t like having his views challenged.

            He finds that challenging.

          • Aristophrenia

            Fair enough, I mean pretty much every single commentator Ive read over the last two years has poured scorn an derision on the points made in the blog with mountains of data to back it up – which kind of backs up my point.

            The track your “blog” has taken is completely discredited – but you know – yeah, China has mountains of reserves it can just sell and bailout all the banks, and of course it can simply pump trillions into its economy and make all the billions of low paid workers consumers – yeeeeeeeahhhhh – that will work

            – I mean, honestly, HOW STUPID CAN YOU GET ??

            ha, ha, lol – smiley face, smiley face.

            p.s.
            Run my own businesses thanks tiger – ive noticed you are high on othe ridicule and very, very low on the substance, typically chosing anything which specifically supports your objectives and stated position rather than a balanced approach to understanding the trith of a situation.

          • Aristophrenia

            Peter Fraser,
            you’re the least respected poster on any of the sites you frequent, all I ever see is everyone correcting your posts, and patronizing your intellect – quite an astonishing feat of humiliation. Literally nothing you post is ever received with any regard or comity.

        • I agree it looks like propaganda generated from within the controlling party room.
          Are those cash reserves not invested in US Treasuries? Are these the reserves they can call upon to prop up their banking system and repay debts incurred within the provinces?

    • I think the jury is still out, although the Japan deflation experience is largely insulated by high domestic savings contributing to the slow melt.

      Not the case in Australia with high off shore borrowing in the past.

      I’m not sure if there maturity asset liability mismatch is over for the banks and unsure if there will be a currency mismatch as well …

  4. rob barrattMEMBER

    Relax
    If you’re a bank in China, it’s not what your balance sheet looks like, it’s whether you’ve been following orders that counts. If the CBRC says it’s OK, then it’s OK. Period.

  5. I’m not worried.

    They will simply write off the bad debts, recapitalize the banks with newly printed electronic money and start all over again.

    Local Governments borrowed from banks which are 100% owned by the Central Government. They owe the debt to themselves.

    Stop using a western understanding of a financial system to analyze China.

    Hell, they already did this once before in the mid 90s.