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Banks fear loans may sour if property falls
00:00 UTC+8 July 19, 2011
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THE banking system of Chinese mainland is one of the largest in the world in terms of assets, after the United States.
The country has three of the world's 12 largest banks in terms of top-tier capital adequacy, according to The Banker magazine: Industrial & Commercial Bank of China (in sixth place), China Construction Bank (eighth place) and Bank of China (ninth place).
According to the China Banking Regulatory Commission's annual report for 2010, these banks, along with Agricultural Bank of China and Bank of Communications, accounted for about half of all lending in China.
Fuelling the sector's growth (and chipping away at its tier-one capital) is real estate. Fitch Ratings estimates that much of the rapid expansion of bank lending - the equivalent of around 140 percent of GDP last year, compared with 111 percent in 2008 - has been for housing, often via local government financing vehicles (LGFVs).
Moody's estimates that China's banks have funded at least 8.5 trillion yuan (US$1.3 trillion) of the 10.7 trillion yuan of outstanding local government debt.
Much of those loans are due in the next few years. While the LGFVs have implicit state backing, they are not risk-free because of the vehicles' interlinking relationship with the banks.
Victor Shih, a political science professor at Northwestern University in Chicago, notes that LGFVs have had an upsurge in bond issuance for property projects in which "the risk ultimately leads back to the banking system."
Because domestic financial institutions are the only players of significant size in the onshore bond market, their LGFV bond holdings are highly susceptible to a property market downturn.
"Those bonds are completely tied to real estate and land value," says Shih. "Without land value increasing, local authorities would not be able to raise money to repay bondholders."
A banking crisis would have a domino effect throughout the economy, predicts Fraser Howie, managing director of brokerage house CLSA in Singapore.
"If you are going to address the misallocation of capital in the banking system and credit system, that's going to have huge knock-on effects on the profitability and viability of the banks," he says.
Vincent Ho, Fitch's associate director in Hong Kong, says LGFV and property-related lending are the primary areas of concern. The agency estimates that a rise in the NPL ratio to between 15 percent and 30 percent could require the equivalent of between 10 percent and 30 percent of GDP to support the system.
China's central bank said in May that the sector's NPL ratio was 1.1 percent, although private-sector estimates put the ratio much higher. Credit Suisse, for instance, suggested in June that the ratio was around 25 percent.
China's regulators are aware of the dangers of the banks' excessive real estate lending and have been pushing for more restraint, while requiring financial institutions to bolster their balance sheets. The central bank has raised reserve requirements for banks 16 times over the past 18 months (currently at 21.5 percent of their deposits) and has upped interest rates three times this year, with the benchmark one-year lending rate now 6.56 percent and the benchmark one-year deposit rate to 3.5 percent since the latest hike on July 6. The country's financial institutions are also being pushed to raise capital from the markets.
Meanwhile, the recent state measures, including monetary tightening and the termination of some infrastructure projects, have been set in motion in a bid to prevent a banking meltdown.
A crisis may not be imminent.
In staving off a crisis, China has several factors working in its favor, including exceptionally strong foreign exchange reserves. But relying on foreign reserves to prevent a domestic banking crisis could be risky, not least because of how much of its reserves are denominated in US dollars. A downgrade of US debt would, indeed, make it more difficult for China to solve its financial problems.
It would be in the interest of other countries to make sure China doesn't fail - especially the US, which would be unlikely to find a holder or buyer of its debt issuance.
(Adapted from China Knowledge@Wharton, http://www.knowledgeatwharton.com.cn. To read the original version, please visit: http://bit.ly/o8CplG)
The country has three of the world's 12 largest banks in terms of top-tier capital adequacy, according to The Banker magazine: Industrial & Commercial Bank of China (in sixth place), China Construction Bank (eighth place) and Bank of China (ninth place).
According to the China Banking Regulatory Commission's annual report for 2010, these banks, along with Agricultural Bank of China and Bank of Communications, accounted for about half of all lending in China.
Fuelling the sector's growth (and chipping away at its tier-one capital) is real estate. Fitch Ratings estimates that much of the rapid expansion of bank lending - the equivalent of around 140 percent of GDP last year, compared with 111 percent in 2008 - has been for housing, often via local government financing vehicles (LGFVs).
Moody's estimates that China's banks have funded at least 8.5 trillion yuan (US$1.3 trillion) of the 10.7 trillion yuan of outstanding local government debt.
Much of those loans are due in the next few years. While the LGFVs have implicit state backing, they are not risk-free because of the vehicles' interlinking relationship with the banks.
Victor Shih, a political science professor at Northwestern University in Chicago, notes that LGFVs have had an upsurge in bond issuance for property projects in which "the risk ultimately leads back to the banking system."
Because domestic financial institutions are the only players of significant size in the onshore bond market, their LGFV bond holdings are highly susceptible to a property market downturn.
"Those bonds are completely tied to real estate and land value," says Shih. "Without land value increasing, local authorities would not be able to raise money to repay bondholders."
A banking crisis would have a domino effect throughout the economy, predicts Fraser Howie, managing director of brokerage house CLSA in Singapore.
"If you are going to address the misallocation of capital in the banking system and credit system, that's going to have huge knock-on effects on the profitability and viability of the banks," he says.
Vincent Ho, Fitch's associate director in Hong Kong, says LGFV and property-related lending are the primary areas of concern. The agency estimates that a rise in the NPL ratio to between 15 percent and 30 percent could require the equivalent of between 10 percent and 30 percent of GDP to support the system.
China's central bank said in May that the sector's NPL ratio was 1.1 percent, although private-sector estimates put the ratio much higher. Credit Suisse, for instance, suggested in June that the ratio was around 25 percent.
China's regulators are aware of the dangers of the banks' excessive real estate lending and have been pushing for more restraint, while requiring financial institutions to bolster their balance sheets. The central bank has raised reserve requirements for banks 16 times over the past 18 months (currently at 21.5 percent of their deposits) and has upped interest rates three times this year, with the benchmark one-year lending rate now 6.56 percent and the benchmark one-year deposit rate to 3.5 percent since the latest hike on July 6. The country's financial institutions are also being pushed to raise capital from the markets.
Meanwhile, the recent state measures, including monetary tightening and the termination of some infrastructure projects, have been set in motion in a bid to prevent a banking meltdown.
A crisis may not be imminent.
In staving off a crisis, China has several factors working in its favor, including exceptionally strong foreign exchange reserves. But relying on foreign reserves to prevent a domestic banking crisis could be risky, not least because of how much of its reserves are denominated in US dollars. A downgrade of US debt would, indeed, make it more difficult for China to solve its financial problems.
It would be in the interest of other countries to make sure China doesn't fail - especially the US, which would be unlikely to find a holder or buyer of its debt issuance.
(Adapted from China Knowledge@Wharton, http://www.knowledgeatwharton.com.cn. To read the original version, please visit: http://bit.ly/o8CplG)
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