China Yuan

There are rising concerns over China’s banking system as the country’s lenders feel the effects of slowing growth combined with a deflating real estate market. Justin Pugsley reports.

Covid-19 lockdown-induced economic slowdowns, bursting property bubbles and fraud are heaping considerable pressure on China’s $56tn banking system, which could soon be inflicted with soaring bad debts. This is seeing a crackdown on the owners of China’s smaller banks. On August 30, the authorities arrested 234 suspects accused of being involved in four rural bank failures, triggering demonstrations by savers who lost their money.

In April, four rural banks in Henan province froze deposits, which eventually saw the police take action to arrest the alleged perpetrators. The banks lured depositors with promises of 18% interest rates. 

The news reflects growing concerns with the country’s 4000 rural banks, which have suffered increasingly frequent runs. These institutions, which account for 25–30% of the country’s banking assets, are often controlled through opaque structures. Along with lax supervision, these banks are vulnerable to fraud and poor risk management practices. They are also deeply intertwined with the shadow banking sector, which has problems of its own.

A wider trend

Michael Pettis, a non-resident senior fellow at the Carnegie Endowment for International Peace, wrote that these increasingly frequent bank failures cannot be dismissed as isolated events. More likely, he wrote, they are part of a wider systemic problem in China that has been brewing for more than a decade. 

Banks of all sizes are feeling the effects of slowing gross domestic product (GDP) combined with a deflating real estate market – the sector makes up nearly a third of the economy. Under a worst-case scenario, the country’s banks could see $350bn in losses just from mortgage defaults. With many builders unable to finish pre-sold apartments due to lack of funds, some homeowners have been pushed into mortgage payment strikes.  

These defaults would also impact the larger banks. The country’s biggest lender, the Industrial and Commercial Bank of China, recently said there had been a 15% rise in loans due to the real estate sector going bad. 

There are also growing doubts over the ability of property developers to meet payments on $13bn-worth of dollar-denominated bonds during the second half of this year. Developers have also borrowed from banks. 

Bank analysts are concerned that if there is a widespread simultaneous failure of small banks it could shatter financial stability, inflicting huge losses on the big banks.

Corrective measures

However, the authorities are taking action. On August 21, Fitch Ratings said that proposals to accelerate non-performing loan (NPL) disposals at smaller banks will broaden bad debt resolution and alleviate asset-quality pressure for these lenders. It believes that most of the NPLs will be swallowed up by asset management companies. 

According to data firm CEIC, China’s NPL ratio was 1.7% in the second half of this year, though some analysts believe it is much higher than that. 

A clean-up focused on six provinces is being led by the China Banking and Insurance Regulatory Commission, the Ministry of Finance and the People’s Bank of China.

The big banks have additional exposures to borrowers involved in Belt and Road Initiative projects, some of whom are struggling with loan repayments, such as Sri Lanka and Pakistan.  

The root of the problem, according to Mr Pettis, is that China’s GDP numbers are politically determined and real estate became a key growth driver. Bank lending decisions are guided by the authorities to achieve GDP goals, meaning that the creditworthiness of borrowers is not always a key consideration. Also, as banks dominate credit creation, so most defaults will end up on their balance sheets. He adds that this approach underpins moral hazard in the financial system.

This article first appeared in Global Risk Regulator, a service from The Banker.


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