Chinese banks will take a hit from a rise in bad loans as a result of the outbreak of the coronavirus, and international banks need to relook at the financing of supply chains, writes Brian Caplen.

In times of trouble China turns to its banks. They were the avenue used by the government to pump demand into the economy following the financial crisis 10 years ago. It is likely, therefore, that they will be called upon again to support the economy as it suffers from the spread of coronavirus.

The problem is that the banks are less well placed to assist than they were back in 2008-09 and they will also take a direct hit to their balance sheets resulting from coronavirus, which was not the case previously.

Some forecasters see China’s economic growth dipping below 4% in the first quarter of 2020 – a two percentage point drop on previous estimates – and more slow quarters will follow if the virus is not contained. In this environment, small businesses are vulnerable and banks can expect a rise in bad loans. One rating agency has come up with a worst-case scenario of an additional $800bn in bad loans giving a nationwide non-performing loan ratio of 6.3%.

Back in 2008-09 the Chinese banks did not take a direct hit to their balance sheets as the subprime bad assets that caused the financial crisis were mostly held by Western banks. On top of this they were in robust health, with lots of spare capital, allowing them to make billions of dollars-worth of new loans and help keep China’s growth rate high as the global economy, and the economies of China’s major trading partners, contracted.  

Today, by contrast, Chinese banking profits are under pressure and even though the People’s Bank of China is ready with huge liquidity injections into the financial system as well as interest rate cuts, it is unclear as to whether this strategy will again be effective. Investors will be cautious on Chinese banks until the situation becomes clearer.

There are also longer term implications for banks everywhere. Are the risks of financing international companies with long supply chains properly priced in? The coronavirus shock shows how fragile supply chains can be and that they can be vulnerable to a whole range of risks. International banks need to look again at their risk exposures taking these new factors into account.  

Brian Caplen is the editor of The Banker. Follow him on Twitter @BrianCaplen

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