Like the rest of the world, China’s banks have been through an unprecedented year. However, unlike many other countries, China has emerged from the Covid-19 pandemic with growth in gross domestic product (GDP), and its banks continuing to increase their Tier 1 capital.
In The Banker’s Top 1000 World Banks ranking 2021, Chinese banks retain their top four places once more, with double-digit growth in Tier 1 capital. Indeed, the combined totals of Industrial and Commercial Bank of China (ICBC), China Construction Bank, Agricultural Bank of China and Bank of China are almost double the amount of the Tier 1 capital held by the four US banks that also make it into the top 10.
Chinese banks were able to rise to the test and were collectively able to achieve a slight growth in net profit year-on-year
The success of China’s banks in coming through the pandemic is down to several factors, not least the quick action of the government when the virus was first detected. Grace Wu, head of Greater China bank ratings at Fitch Ratings, says: “The ability of China to contain the virus within a relatively short period of time meant the authorities didn’t need to do as much to stimulate the economy. They did not need to aggressively cut interest rates, which impacted many global banks last year.”
Government action
China’s government and its central bank provided support to ensure the banking sector was fully supported through the economic impact of the lockdowns. Brian Coulton, chief economist at Fitch Ratings, says: “Early on in the pandemic, China loosened policy pretty aggressively, in the form of stronger credit and infrastructure investment through the second and third quarters of 2020. But since the fourth quarter, as the economy recovers, we were seeing the sectors boosted by the earlier macro policy stimulus easing. We have seen credit growth numbers slow and this has continued into 2021.”
Even with the impact of the pandemic taken into account, China saw GDP rise by 2.3% during 2020, according to the National Bureau of Statistics. Other metrics are also performing strongly. Chen Huang, senior vice-president, financial institutions group at Moody’s Investors Service, says: “Chinese banks have weathered the pandemic well, with net profit declining only by 3% year-on-year in 2020. The performance was underpinned by the country’s swift economic recovery. The banking system entered 2020 with a strong loan-loss reserve buffer, with non-performing loan (NPL) coverage at 186%, and a solid capital base, with core Tier 1 ratio at 10.9%, providing them with the capacity to withstand the economic disruption in the first half when the pandemic hit the country hard.”
Geoffrey Choi, EY
Steps taken to strengthen the banking sector ahead of the pandemic reaped rewards in keeping the sector strong throughout the turbulent months of 2020. Ms Wu says: “The reform progress seen in recent years in areas such as tackling off-balance-sheet exposures have paid off; shadow financing activities have declined by about 30% from the peak in 2017. We did see a one-off increase in overall system leverage in 2020 as GDP growth was much weaker due to Covid-19, but our expectation is that China’s system leverage will stabilise at a similar level.”
Geoffrey Choi, EY Asia-Pacific financial services assurance leader, says: “In a sign of their operational resilience, Chinese banks were able to rise to the test and, despite the huge pressures of the pandemic, were collectively able to achieve a slight growth in net profit year-on-year – up 0.1% from 2019. EY analysis of the listed banks’ 2020 results also showed an increase in the combined operating income, while capital adequacy ratios remained stable. However, weighted average return on net assets decreased slightly and the average return on total assets was also down, primarily due to the slower net profit growth.”
Covid response
The resilience seen during the pandemic also built on the swift response of the government and the banks alike to protect both corporate and retail customers. China extended support to small and medium-sized enterprises (SMEs), with the State Council announcing in December 2020 that these companies could defer loan repayments past the first quarter of 2021 if necessary. Banks lending to these small companies were also permitted to keep the support from the government beyond the end of 2020, where needed.
Individual banks developed bespoke responses to support their customers. Jin Yu, chairman of the Bank of Shanghai (BOSC), says: “The bank formed an online and open service platform for its SME clients and rolled out a set of products, such as online microcredit and online electronic bill financing, to better meet their needs. Efforts were also made in supply chain financing, and BOSC e-chain and BOSC assets pool were tailor-made to deploy an end-to-end services ecology, covering supply chain companies from both up and downstream.”
Supporting SMEs while still managing credit risk was a priority for ICBC, according to Zhang Weiwu, senior executive vice-president at the bank. He says: “In accordance with market-based and commercial principles, we allowed customers who had temporary difficulties in repaying their loans, especially SMEs, to defer their principal and interest payment for a certain period of time, a relief measure that effectively supported companies in resuming operation and work. On the other hand, we continued to prevent and control credit risk properly, strengthened the identification and mitigation of loan risk, and intensified the collection and disposal of NPLs, so as to bring risks under efficient control and keep overall asset quality stable.”
Xu Li, chairman of Shanghai Rural Commercial Bank (SRCB), says the bank has extended long-term loan support to customers in the worst impacted sectors, though he notes industries that had been severely hit in the pandemic, such as catering, tourism and culture, have bounced back as the country has reopened.
“Working in concert with the real economy under the impact of the pandemic, SRCB has temporarily adjusted some approval mechanisms, mobilising a green fast-track for priority to approve loan programmes such as pandemic relief loan, supply maintenance loan and work and production resumption loan,” Mr Xu adds.
There was also better monitoring of companies that were most at risk of getting into difficulty. Mr Jin says: “Considering the changes in the external business environment, [BOSC] adjusted its credit policies and risk control strategy in a dynamic way, and carried out targeted precise and differentiated credit allocations. Meanwhile, the bank leveraged big data and artificial intelligence (AI) technologies to carry out automatic risk monitoring and selection, improving its active risk management capability, and ensuring its sound and stable asset quality.”
Online lender WeBank used its WeiYeDai platform, which provides unsecured business loans, to support those who were badly affected by the pandemic. These customers are small; 64% have revenue of less than Rmb5m ($772,000) and 66% lack a business credit history. Demand for support increased during the pandemic. At the end of 2019, the platform had provided credit services for 230,000 small businesses. As at the end of 2020, WeiYeDai had served more than 1.88 million micro SMEs and provided credit services to more than 560,000 of them.
WeBank president Nanqing Li says it launched focused services to target badly hit market segments, especially those impacted by limited assets and with no collateral. “The supply chain financial product has differentiated features, in that it does not over-rely on core enterprise credit and is not dependent on collateral,” he says. “Thus, this product can better fulfil the financial needs of suppliers and distributors that are highly frequent, short in duration, small in ticket size, and, at times, urgent in nature.”
NPLs stay stable
While the banks are keen to support their customers through this difficult period, the risk of shoring up a potential increase in NPLs for the future is ever present. “The weighted-average NPL ratio of China’s listed banks increased slightly in 2020 from the end of 2019,” says EY’s Mr Choi. “However, the overdue loan ratio has actually decreased, as banks stepped up their efforts on the disposal of NPLs and implemented regulatory policies related to the fight against the pandemic. This helped, to a certain extent, mitigate the impact of the economic downturn and kept asset quality relatively stable.”
Yu Lingqu, China Development Institute
Vivian Xue, director of financial institutions at Fitch Ratings, says for the first quarter of 2021 the level was similar to before the pandemic, as the NPL ratio was around 1.8% and the loan loss allowance ratio was 187%. Relief loans reached Rmb7.3tn, accounting for as much as 17% of total SME loans.
“We believe this has remained stable due to the loan relief measures implemented, as well as the banks’ active NPL resolution,” Ms Xue says. “Over the year, there was Rmb3tn of NPL resolution, compared with Rmb2.3tn in 2019. For 2021 to 2022, the authorities have indicated higher NPL resolution amounts.”
NPLs have been driven down by focused efforts in previous years, especially the adoption of International Financial Reporting Standards 9, while transparency and the data around asset quality have both also improved.
Moody’s Ms Huang says the provisions made prior to the pandemic have helped to keep the levels manageable. “Lowered NPL ratios were also driven by banks’ efforts in accelerating NPL disposal in recent years. This process spurred banks to set aside high credit costs to replenish loan-loss reserves. NPL coverage was sufficiently stable from the pre-pandemic level at 187% of total NPLs at the end of the first quarter 2021.”
Zheng Wanchun, vice-chairman and president of China Minsheng Bank, gives a comprehensive overview of how the bank has tackled the NPL issues: “As at the end of 2020, total loans overdue for over 90 days of the Group（China Minsheng Bank and it’s subsidiaries）amounted to Rmb51.8bn, accounting for 1.35% of total loans, down by 0.02 percentage points from the end of the previous year. The ratio of loans overdue for over 90 days to NPLs was 73.88%, down by 14.12 percentage points from the end of the previous year, the best in the past three years.”
Specific industries affected
Mr Zheng explains the corporate NPLs of China Minsheng Bank were mostly from a small group of industries. “The increase in corporate NPLs mainly concentrated in three industries hit hard by the pandemic, namely transportation, warehousing and postal services, wholesale and retail, and mining. The increase of NPLs in the three industries accounted for 103% of the increase in total corporate NPLs. When the pandemic situation gets better and the resumption of work and production accelerates, the three industries are expected to gradually recover and the asset quality of the bank is expected to be stabilised.”
Ping An Bank, meanwhile, believes the NPL rate will be further improved in 2021, and the bad asset provisioning will be lower in 2021 than for the previous year. This represents a provision of Rmb12.9bn for the first quarter of 2021, a year-on-year decrease of Rmb1.8bn. A Ping An spokesperson says: “As our bank has increased efforts to write off non-performing assets in 2020, our bank’s non-performing ratio dropped to 1.18% at the end of 2020, topping the benchmark joint-stock banks. In 2020, non-credit non-performing assets consolidated on the financial statements have been basically written off. Therefore, the scale of write-offs in 2021 is expected to decrease significantly compared with 2020.”
It needs to be stressed that NPLs are an ‘imperative evil’ in order to achieve economic recovery from the pandemic
Any increase in NPLs needs to be seen as part of the process rather than a systemic risk. Yu Lingqu, deputy director of finance and modern industry department at the China Development Institute, says: “It needs to be stressed that NPLs are an ‘imperative evil’ in order to achieve economic recovery from the pandemic. In the future, risks and negative impacts caused by NPLs can be moderated as the economy revives.”
The CBDC future
As China’s banks get back on an even keel, they are having to embrace a banking economy that has continued to evolve even during the pandemic. Also, 2021 is the start of the country’s 14th five-year plan, which proposes the further development of fintech and to accelerate the transformation of financial institutions. This will present banks with both new challenges and opportunities to bring greater value to their customers and the Chinese economy.
Most significantly, the People’s Bank of China (PBOC) has continued to push forward with the development of a central bank digital currency (CBDC), which is still in the pilot stage, with trials being carried out in Shenzhen, Suzhou and Chengdu.
Elaine Xu, Fitch Ratings
Elaine Xu, associate director of financial institutions at Fitch Ratings, says the banks have an integral role to play. “The creation of China’s CBDC will involve commercial banks and payment companies for distribution, identity validation and anti-money laundering measures. In terms of impact on the banks, they will have access to large amounts of complex payments data, which can be used for their fintech enhancement, such as machine learning capabilities,” she says. “However, it is still in the early stages and we do not have a timetable for the release.”
The development of China’s CBDC is positive from the perspective of it bringing liquidity back to banks from the fintechs, which have been operating in a more relaxed regulatory environment, says Alicia García-Herrero, chief economist for Asia-Pacific at Natixis. However, she says, it may impact on the activities of some institutions. “Still, it would pave the way for more granular regulation technologies in the future, which will allow the central bank to implement more targeted monetary policies. This could mean less room for regulatory arbitrages and shadow banking activities, which are usually the businesses for smaller banks.”
The development is something the banks are watching closely to see the impact it may have on their business models. Minsheng’s Mr Zheng says: “The previous advantages of financial institutions in cost management and customer acquisition gained through scaled operations will, to a large extent, depend on their capabilities in digital technology innovation and application in the future. As a result, commercial banks are urged to intensify innovation, accelerate digital transformation and apply cutting-edge technologies widely to improve customer experience, consolidate customer base and enhance core competitive edge.”
China is taking a two-tier approach to the CBDC, with the PBOC at the top and the commercial banks, telecom companies and big tech companies comprising the second tier. This structure ensures the banks remain relevant as intermediaries for deposits and funds in the system — in contrast to a disintermediated model, whereby the central bank would allow users to open accounts that it would manage directly.
Prospect for growth
Fern Wang, director at S&P Global Ratings, says the banks should be looking at this as a growth prospect. “The development could bring in new business opportunities and customer acquisition channels for commercial banks as they partner with various third parties to build an ecosystem around e-yuan wallets. With even more payment data available as the digital currency replaces M0, or cash, we will likely see a further acceleration of the usage of big data and AI in customer acquisition and risk management.”
The PBOC has been cautious in limiting the risk of financial disintermediation, as the structure allows them to continue to compete in payments. “There is a potential threat to the banking system’s deposit base, but the impact is carefully managed thus far by the PBOC,” Ms Huang says. “The e-yuan, by design, is to replace cash, limited to small-amount transactions (large transactions are subject to fees with no anonymity guaranteed), and bears no interest. These limitations aim to mitigate the potential deposit migration to the CBDC as a risk-free medium of exchange, which would be disruptive for the banking system and increase banks’ funding costs.”
China’s CBDC will involve commercial banks and payment companies for distribution, identity validation and anti-money laundering measures
There are different factors to take into account. If the CBDC removed cash, this would cut costs and reduce the risks related to the safekeeping of currency and the maintenance of ATM machines. It would also give the banks an opportunity to replace obsolete IT systems and lay the groundwork for a new digital economy. However, it also raises regulatory, business and technological issues.
Ms Wang says the biggest concerns may come from the smaller banks, which face another set of digital changes. “Banks would need to further upgrade their technology infrastructure to accommodate the change, and enhance and scale up their capability in anti-money laundry, data privacy and payment security” she says. “The investment required for improvement could be prohibitive for smaller banks with fewer resources.”
As China’s juggernaut economy continues to roll forward, and the demands of the central bank and the government increase, the banks have a careful balancing act to execute. For the larger state banks, it appears the change will be manageable — but the country’s smaller banks might be hoping for some assistance in completing the manoeuvre.
Continue reading: Economic rethink needed to boost China’s growth
