Bad debt surge threatens Chinese banks’ balance sheets

The capital levels of some Chinese banks are at risk of falling below a crucial threshold intended to protect them from financial contagion, as lenders are faced with a spike in bad debts due to the coronavirus.

Beijing called on banks to play a key role in supporting businesses struggling to survive the Covid-19 epidemic. Regulators have asked lenders to prepare for much higher levels of non-performing loans as the economy slowly recovers after the public health crisis, which temporarily shut down parts of the industry and supply chains .

But many Chinese banks are already grappling with asset quality issues and lack the capital and profitability for the new loans needed to fuel a recovery.

Analysts are divided on the amount of bad debt that the current economic downturn will create. But even the most modest forecasts show that bank capital could fall to precarious levels.

Non-performing loan ratios for banks rated by Fitch are expected to reach around 3.5%, up from 1.5% in June last year, the rating agency said.

Such a scenario would push the level 1 common equity ratios of China Minsheng Bank, Hua Xia Bank and China Guangfa Bank below the minimum regulatory requirement of 7.5%, said Fitch. A number of other medium-sized banks are also expected to approach this threshold.

“In the end, it is always the medium and small banks that will see the greatest impact on the quality of their assets,” said Grace Wu, director of Fitch’s large Chinese banks.

The CET1 requirement aims to protect banks against financial crises. Lenders who fall below this level are considered to be at high risk of liquidity problems in the event of a shock to the banking system.

Minsheng Bank had total assets of Rmb 6.2 billion ($ 873 billion) in September, which makes it larger than Standard Chartered but still much smaller than large Chinese banks such as ICBC.

Moody’s has lowered the outlook for six Chinese mid-level banks from stable to negative due to concerns over credit quality. The rating agency noted that the Bank of Nanjing “has considerable exposure to the manufacturing and wholesale and retail sectors, which are seriously affected by the coronavirus epidemic”.

S&P warned that up to 11.5% of total loans in the commercial banking system, or about $ 2.1 billion, could become “impaired” – either ineffective or late. This could eventually exhaust the sector’s regulatory capital buffers, said S&P, leaving some lenders vulnerable to liquidity shocks.

The independent research firm Rhodium Group recently declared to have identified 1.5 billion Rmb of bad debts in default, unrecognized or undeclared among the 49 Chinese banks listed on the stock market beyond their official rate of nonperforming loan of 2% . This suggests that the true bad debt rate is much higher than indicated.

Over the past two years, Chinese regulators have been paying close attention to weak links in the banking system.

In May of last year, the government took over Baoshang Bank, the first direct intervention of its kind in almost 20 years. In the following months, two other banks with poor quality assets benefited from government-backed bailouts.

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