Investors have doubts about Chinese banks’ ability to withstand the competition in a market where tech companies have a solid grip, writes Brian Caplen.

Statistics about Chinese banks are always impressive. In The Banker’s Top 1000 World Banks ranking for 2018, China’s banks hold the top four slots globally in terms of Tier 1 capital. They have the highest profits and the lowest costs. Overall, they account for one-third of global profits. They increased their aggregate Tier 1 capital by $337bn (or 20%) in 2017.

But they are also in investors’ sights as banks that could face credit losses and whose business is most under threat from big tech companies. The challenge they face is tougher than that faced by most developed country banks. In China, companies such as Alipay and WeChatPay have become leaders in peer-to-peer payments and almost half of domestic payments now flow through third-party platforms. Chinese payments conducted through e-wallets account for nearly 40% of the global total.

This is affecting the banks' valuations. For many years, banks in emerging markets were valued more highly than those from developed markets, given their higher growth prospects and lesser impact of the financial crisis. But in 2017, the price-to-book value (market cap divided by net asset value) of developed country banks overtook those of emerging markets, according to research presented in the latest McKinsey Global Banking Annual Review. Price-to-book valuations of emerging market banks have decreased by half since 2010, with Chinese banks contributing to this change.

McKinsey puts this down to rising credit losses in emerging markets, with the extra risk and capital costs that this implies. Non-performing loan ratios in Chinese banks are currently low but “uncertainty about the balance sheet composition of Chinese banks is causing jitters”.

Then there is the tech threat. “Stiffening competition from digital firms and peer-to-peer companies has thus far had greater impact in emerging markets than in developed markets,” says McKinsey.

But this does not mean that investors are bullish on banks in developed markets. Bank stocks are currently underperforming even in sluggish sectors such as utilities, energy and materials. Investors worry about future earnings amid disruption to the banks’ traditional role in financial intermediation. All banks need to consider their strategy carefully if they are to negotiate these challenges successfully. 

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

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