CHINESE banks face a delicate high-wire act next year as the nation continues to restructure its economy and the booming property market leaves a trail of rising debt.

The world’s largest lenders by assets, Chinese banks must balance performance growth with financial risks, analysts said.

The combined profit of China’s five biggest banks in the third quarter rose 0.8 percent from a year earlier, the smallest quarterly gain in decades. Industrial and Commercial Bank of China and Construction Bank of China both reported bad-loan buffers below a regulatory minimum of 150 percent.

Economic restructuring has cooled the rapid growth rates that catapulted Chinese banks to a decade of strong profit. Weaker domestic and global demand has increased the borrowing ratios of state-owned enterprises and the lenders’ portfolios of non-performing loans.

Dud loans stood at 1.49 trillion yuan (US$215.9 billion) by the end of September, adding to the 11-year-high of 11.44 trillion yuan from a quarter earlier. The bad-loan ratio rose to 1.76 percent, the country's top banking regulator said.

Many foreign investors are expressing fears that China’s debt burden is at the hair-trigger of a boom-to-bust cycle, given the nation’s inability to wean debt from the financial system. Others continue to assume that the government’s determination to maintain a stable economy won’t let that happen.

Chen Li, senior A-share strategist at Credit Suisse, told Shanghai Daily that there are some promising signs, such as the growth of new bad loans slowing in the East China region.

“If you add up the government, corporate and household debt, it’s true that China hasn’t deleveraged the system,” Chen said. “But if you look upon the past in a global context, the leveraging of a financial system usually shifts from one sector to another without decreasing the overall load.”

Judy Zhang, an analyst from Citi Research, echoed that view. She wrote in a recent note that the government is capable of resolving the non-performing loan issue, but she said the key is “how to allocate new credit and conduct reform.”

In 2016, Chinese lenders banked on mortgage loans to offset the risks of worsening corporate debt. Household loans, mainly mortgages, jumped to a record 4.69 trillion yuan in the first 10 months of the year to 2.26 trillion yuan. They accounted for 43 percent of total new yuan loans in the period.

After regulatory authorities tightened the reins on the property market in October, new credit is expected to flow mainly into local infrastructure projects in 2017, said Chen at Credit Suisse.

Underpinning that forecast are factors such as the central government’s reliance on construction spending to support economic growth and improvement in the creditworthiness of local governments after massive debt swaps.

About 14 trillion yuan of the current 17 trillion yuan of local government debt will be swapped into bonds at lower cost and longer maturity by the end of 2017, according to the annual government plan.

“Strong mortgage and infrastructure credit growth fits the government’s goal of shifting leverage from corporates to households and the government,” said Zhang. “But we should be aware of unexpected consequences, such as higher leverage driven by a boom in entrusted investments and a wider mismatch between assets and liabilities.”

Fleeing money

In addition to tackling the mounting debt load, China is continuing to slow the flood of money fleeing the country and eating into its foreign reserves.

That campaign won’t be helped much by the US Federal Reserve’s decision last week to hike its benchmark interest rate for the second time in a decade, by 0.25 percentage point. The US central bank hinted that it could raise rates three more times next year.

China’s yuan tumbled to fresh eight-year lows after the Fed decision, deepening concerns about shrinking foreign reserves.

“If the US increases its interest rate in a relatively fast tempo, yields on US Treasuries will rise above equivalent bonds in China, causing more capital outflows,” said Zhao Yang, chief China economist at Nomura.

“Policymakers will have to decide whether China does or doesn’t tighten its own money supply to curb that trend,” he added. “But if the government does, there would be pressures on domestic asset prices and economic growth.”

Zhao predicts that monetary policy will remain neutral for China next year as part of government efforts to keep roaring property prices in check.

To ease the burden of mounting bad debt, China also widened the channel whereby banks can transfer bad loans from their books this year.

The China Banking Regulatory Commission is relaxing rules that used to allow only one asset management company per province to “buy” bad bank loans, local media reported in late October. That will especially assist heavily indebted provinces that are struggling with reductions in coal and steel production.

“More players in the game are good for banks in selling their non-performing assets at a more competitive price,” said Wan Ying, an analyst at rating company Moody’s who monitors the Chinese banking sector.

The State Council, China’s cabinet, last month introduced new guidelines aimed at lessening corporate debt ratios through a new round of debt-to-equity swaps and increased use of debt securitization. But question remains on the scale and effectiveness of these tools, analysts said.

“The government's attitude remains cautious,” said Chen. “The nature of a bank or financial institution that takes deposits from savers restricts the possibility that such swaps will happen on a large scale.”

For smaller lenders, raising funds from initial public offerings on mainland equity markets remains one solution to buffer their capital from the risk of bad debts and to boost their lending capability.

Seven regional and rural banks went public in 2016. The biggest float, by the Bank of Shanghai, raised 10.7 billion yuan.

However, smaller players also face a harsh crackdown on their ability to offer wealth management products. Lenders in the “shadow banking” realm usually have high proportion of assets and lending off balance sheets.

Operational restructure

According to Deutsche Bank estimates, wealth management products accounted for 15 percent of banking sector assets last year. Total assets of banks in the first nine months of the year doubled from five years ago to 222.9 trillion yuan.

Banks are struggling to restructure their operations, adopt more technology into their systems and reduce salaried employees.

The number of bank employees at China’s “Big Four” lenders shrank for the first time since 2007, when headcounts were first reported. Employees in the first six months of this year fell by 25,300 to 1.62 million.

The reduction reflects the shift from offline to online banking and efforts to control costs amid cooling profits, McKinsey & Co said in a recent banking report. It’s hard to calculate the scale of such a talent shift, but the trend is expected to continue as mobile banking becomes the norm, the report added.

Mainland banks in general have allocated only between 1 percent and 3 percent of their income to technology innovation and digitalization, lagging global rivals with ratios as high as 20 percent.

The financial landscape is changing, amid fierce competition from credit channels offered by companies such as Alibaba Group’s financial arm Ant Finance, McKinsey said.

“Transformation and innovation will have an overarching impact on the future business model of the banking industry,” said Han Feng, an associate partner at McKinsey. “We believe that the future winners will be those that take action the most quickly.”