Falling Dominos: An Indication that reality is hitting state-owned Chinese banks hard

May 5, 2020

2 min read

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What's going on here?

Large state-owned Chinese banks, like the Industrial and Commercial Bank of China (ICBC) and the Bank of China (BOC), must brace themselves for an incoming wave of bad debt from smaller Chinese businesses and banks.

What does this mean?

Rhodium Group (an independent research firm) recently reported an outstanding sum of £114bn in overdue/bad debts is currently spread amongst 49 Chinese banks listed on the Hong Kong Stock Exchange and the Shanghai Stock Exchange. This sum far exceeds the official 2% non-performing loan rate (which is an indicator that a borrower has not made regular bank payment for 90 days or more). The Standard & Poor’s (a provider for credit ratings) further warns that up to 11.5% of the total loans in the Chinese commercial banking system could become non-performing or late. 

Both reports point to the conclusion that the true proportion of Chinese bad debt in the lending market is much higher than what is currently being reported.

What's the big picture effect?

A decade of excessive credit spending in a “banking spree” has resulted in major Chinese banks saddled with heavy bad debts. These debts piled up due to a loosened Chinese monetary policy resulting in cheap debts  being offered as a means to combat slowing growth. In practice, this means low-interest loans are being offered to companies in order to fuel activities such as large-scale infrastructure projects to cross-border M&As/ takeovers in growing international markets. But coupled with loosening official definitions on what “risky” or “bad debts” mean, the relevant authorities have essentially assisted banks in delaying the booking of bad debts. This is bad as it creates incentives for companies to defer payment for loans they cannot afford with little repercussion.  

The Chinese state’s lack of transparency around masking unpaid loans is a long-standing issue which has been under regulatory scrutiny from the China Banking Regulatory Commission (CBRC). As businesses show no sight of recovery, Beijing finally called on major state-owned banks to shield defaulting regional/rural banks by continuing its lending activities to troubled small/micro businesses who were amongst the hardest hit whilst lowering interest rates. Lenders additionally agreed to allow small businesses to defer payments of up to £100bn in debt. It is hoped by doing so that businesses can continue paying its employees, and most importantly, stay in operation. 

Ultimately, this act will damage the quality of banking assets (mostly made up of loans) as well as the profits/dividends shareholders can recuperate this year.   Asset quality will see a drop as these debts are unlikely to be repaid on time or at all, which will force banks to write them as bad or non-performing debts. In turn, the reported profitability of these banks takes a hit as interests on loans are not being paid back.  Therefore, the question of whether this policy is sustainable for the long-term is unclear. As the issue of bad debts has only just reared its ugly head, the extent and full effects on the economy remains to be seen.

Report written by Roslyn Lai

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