Surge in bad loans in China – How worrying is this trend and will it derail economic growth momentum?

Surge in bad loans in China – How worrying is this trend and will it derail economic growth momentum?

Bloomberg News Online reported on October 31, 2013 that the amount of loan losses, as measured by nonperforming loans, incurred by the major Chinese banking giants, including Bank of China, Ltd. (BOC), Industrial & Commercial Bank of China Ltd. (ICBC), China Construction Bank Corp. (CCB), Agricultural Bank of China Ltd. (Agbank) surged 3.5 percent during the quarter ending September 30, 2013 to a combined total of Chinese yuan 329.4 billion (USD 54.0 billion). This is according to data compiled by Bloomberg News based on the latest third quarter results. Combined profits rose to Chinese yuan 209.0 billion.

Given the backdrop of the loan write-offs, coupled with a slowing Chinese economy, it does raise the possibility of an industry-wide default of all these major local banks if they have not received any backing or some form of credit line from the Chinese government in order to maintain financial stability and public confidence in the solvency of these Chinese banks. There are also questions as to whether the slowdown is turning out to be a financial meltdown for these major Chinese banks. Will it spark off panic among depositors, or cause a major ‘run’ on the ATMs and front desks of the banks? Based on past observations, I believe it is highly unlikely that the situation will be blown out of proportions such as the scenes readers might have watched on their television sets during the early days of the Euro crisis, and the major Greek banks halting all banking operations across the nation, sparking panic and protests. The Chinese government will not tolerate such events happening in its country, and is likely to have put in place measures to minimise the fallout of a potential debt crisis looming.

According to the Oct. 31 Bloomberg News report, yields on AAA-rated five year commercial bank bonds rose 80.0 basis points (bps) (1.0 bps is equivalent to one-hundredth of a percentage point) since June 2013 to the average of 5.55 percent. This is according to an index reading taken off from Chinabond, a government debt clearing house. Based on the latest chart data obtained from Thomson Reuters, the overnight Shanghai Interbank Offering rate or SHIBOR climbed 4.45 percent on October 29, 2013 to 5.23 percent the following day. Readers might have recalled that the country’s central bank, People’s Bank of China (PBOC) has intervened on Oct. 29 through an injection of liquidity in the monetary system, but for this case, coupled with this latest revelation on the extent of the loan write-offs situation, the actions by PBOC proved to be short-lived, and unlikely to quell the growing worries about the overall financial health of China’s banking system. As early as the start of trading across the Asia-Pacific region on October 31, 2013, the American Depository Certificates (ADRs) of the major Chinese banks trading in New York declined in after-hours, highlighting the growing worries over the extent of the banks’ losses, and how the Chinese government might approach towards dealing with these bad debt issues, while minimising the fallout of a potential debt crisis.

Bloomberg News quoted a report released by a major credit rating agency, Fitch Ratings, showed that interest owed by borrowers have risen to 12.5 percent of Chinese gross domestic product (GDP) in 2013 to 7.0 percent in 2008. Fitch estimated that this figure might rise to as high as 22.0 percent by 2017, which could “ultimately overwhelm borrowers”. Debt-to-GDP figures have also risen to a range of approximately 200.0 percent, which adds to the many banking woes that the country is currently facing. I believe that the latest revelation of massive bank loan losses and the implications it might have on China’s future economic growth will be on many Chinese leaders’ minds as they are preparing for the upcoming November 2013 Plenum meetings following the leadership transition which took place in April 2013.

There are several key banking statistics which Bloomberg News has uncovered, including the amount of lending which rose to Chinese Yuan 2.2 trillion of new loans, equivalent to an approximately 18.0 percent compared to last year. The average non-performing loan ratios of the top four banks rose to 1.02 percent as of the quarter ending Sept. 30, versus 1.01 percent. These banking statistics are quite startling, which has impacted not only the financial sector, but has also affected other industries, namely the Industrials and transportation equipment sectors, on top of existing and possibly new restrictions on borrowing limits. It is clearly a significant risk that China will not want to be seeing it continues as a growing trend.

In conclusion, I believe that the official Chinese government’s estimate of 7.5 percent economic growth pace will continue to remain unchanged, and economic momentum shall fairly be positive heading to the end of 2013. Unless the Chinese government offers some form of debt forgiveness, or plans to recapitalise the bank’s finances through the use of government funds, the worries expressed through the interbank SHIBOR rates, and subsequent financial earnings releases by the Chinese banks will likely continue to remain as one of risk factors to take note of when it comes to investment decision-making matters.

About Hock Meng Tay - Chief Editor, Asia-Pacific Region

Hock Meng Tay, CAIA has written 181 post in this blog.

Chief Editor, Asia-Pacific Region Hock Meng Tay is a CAIA holder and is currently taking CFA qualification. He has over 10 years of experience working as research associate in several investment companies.He is an expert in financial analysis and has published research reports in his current role. He obtained his Masters of Business Administration in Integrated Management and Masters of Arts in Economics while serving his internship in Starsource Inc

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