Can Chinese Banks Survive The Downturn?

HONG KONG/SHANGHAI (Reuters) – With signs of cracks appearing across China’s credit system, concerns are growing that the country’s banks may be ill-equipped to handle a drop in the Chinese economy.

Corporate collapses and defaults in the last few weeks, together with a tightening interbank lending market, show that China’s banks are hardly in the clear when it comes to negotiating their way through the global financial turbulence.

Some of the country’s financial groups, including large, state-run institutions such as ICBC (601398.SS) and China Merchants Bank (600036.SS), have the benefit of government ownership and relatively small exposure to the West’s subprime mortgage mess.

The main concern is focused on smaller commercial banks, whose regional concentration makes it harder to withstand a downturn than the larger, more diverse state-run banks.

There are around 8,500 rural financial institutions and 125 city commercial banks, with Bank of Shanghai, Bank of Nanjing (601009.SS) and Bank of Hangzhou among the big name city lenders.

“The main risk to China’s banks is rapid slowdown in the economic growth and the crystallization of the latent credit risks,” said Ryan Tsang, senior director of Greater China corporate ratings at Standard & Poor’s.

Should smaller banks come under serious pressure or fail, that could lead to weakening depositor confidence and a chain reaction up the banking system.

“Depositors might move a significant portion of their deposits to state owned commercial banks and other banks that they consider as ‘safe’,” Tsang said. “That would put other Chinese banks that are facing tight liquidity in an even more difficult position.”


China’s government this month toughened its guidance on capital ratios at some banks, a move seen as a pre-emptive step to prevent Chinese banks from repeating their near-bankrupt status roughly five years ago.

That was when the government bailed out some of China’s largest banks that were hobbled by non-performing loans.

The recent collapse of privately held Jianglong Group, a major textile company in southern China, and loan defaults by steelmaker FerroChina (FERR.SI) was a grim sign for commercial lenders worried about bad loans piling up again.

Take, for example, export-focused Zhejiang Province where around 20 percent of small-and-mid sized companies made a loss during the first half of this year, according to GF Securities.

That’s not encouraging for Bank of Ningbo, a midsized lender with a bad loan ratio of only 0.4 percent but whose clients are mostly small private firms concentrated in Zhejiang.

Loans overdue for up to 90 days jumped 53 percent to 2.292 billion yuan ($335.4 million) in the first half of the year at Fujian-based lender Industrial Bank (601166.SS). Those loans are often classified as non-performing loans.

Industrial Bank is also highly exposed to the property market, with 14.29 percent of total corporate lending extended to developers — the average among peers being around 10 percent, analysts say.

“Although the bank’s overall bad loan ratio is still low, the rise in overdue loans signals increasing risks in asset quality, especially during an economic downturn,” said Wang Yifeng, analyst at TX Investment Consulting Co.


Interest earned on loans still comprises upwards of 70 percent of Chinese banks’ operating income, making credit risk and the condition of borrowers the top focus for Fitch’s analysis of Chinese banks, the ratings agency wrote in a September 22 report.

Fitch points to rising borrower stress, an increase in avoiding credit restrictions and tighter liquidity as chief among its concerns, noting that small export and property businesses are under particularly severe pressure.

The overall view is that Chinese banks in the last five years have a lot more loan-loss reserves on hand and are in a better position than ever to withstand global market turmoil, Fitch senior director Charlene Chu said in an interview on Monday.

“But this is still an emerging market. There’s still a lot of risk management and internal control issues, and there are other things happening in the broader economy in terms of borrowers that point to more difficult times ahead,” she said. “So, it’s going to be bumpy.”

By Michael Flaherty and Samuel Shen
(Editing by Jean Yoon)