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Profit growth slowdown adds to banks' capital strain
By Fitch Ratings |
March 25, 2013, Monday
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Print Edition
Print Edition
LOWER earnings growth at Chinese banks is likely to weaken internal capital generation and put further pressure on capital in 2013-2014.
Earnings growth of Chinese commercial banks slowed noticeably in 2012, with aggregate net profit rising 19 percent against an unsustainably high 36 percent in 2011 and 2010. Slowing earnings can be temporarily offset by cutting expenses and impairment charges, but longer term more capital will be needed to sustain aggressive asset growth and remain compliant with tougher regulatory buffers.
As we expected, the main sources of earnings pressure were: rising funding costs as liquidity further weakened; rapid growth of non-loan credit, which tends to be lower yielding; and slower growth of net fees and commissions. We expect all these trends to intensify in 2013-2014, and be exacerbated by further moves toward interest rate liberalization, which will lift already rising funding costs.
Another critical factor clouding the 2013-2014 profit outlook is Chinese banks' low impairment charges, which have noticeably lagged behind overall credit growth. Loan loss reserves have been rising - reaching 2.8 percent of total commercial bank loans at end-2012 (2010: 2.5 percent) - but this fails to take into account the large and growing portion of new bank credit being extended outside loan portfolios, where reserves are typically nil.
Shifting greater amounts of credit into such channels allows Chinese banks to temporarily maintain low impairment charges and preserve net income, but this comes at the expense of weaker future loss-absorption capacity. Even a modest turn in the credit cycle could result in much higher credit costs than in recent years. The aggregate net profit of commercial banks totalled US$197 billion in 2012, compared with a total stock of bank-related credit of nearly US$14.5 trillion, highlighting how quickly rising credit costs could significantly erode profitability.
Although Chinese banks' performance appears solid by global comparison, headline profit data can be misleading. Subtracting dividends and other charges, growth of retained earnings was below growth in assets and business volume, which were 18 percent and 20 percent in 2012, respectively (the latter figure our estimate). Unable to grow equity to a level commensurate with global peers, Chinese banks remain among the most thinly-capitalized across all emerging markets. This raises the possibility of significant dividend cuts in 2013-2014 and the need for fresh capital injections.
Thin capital, weakening profitability and liquidity, rising exposure to shadow banking, and continued aggressive growth are particular concerns for China's mid-tier banks, and were among the key drivers of our downgrades of ratings of China CITIC Bank, Industrial Bank, and Ping An Bank in February 2013.
The above article originally appeared as a post on the Fitch Wire credit market commentary page at www.fitchratings.com. All opinions are those of Fitch Ratings.
Earnings growth of Chinese commercial banks slowed noticeably in 2012, with aggregate net profit rising 19 percent against an unsustainably high 36 percent in 2011 and 2010. Slowing earnings can be temporarily offset by cutting expenses and impairment charges, but longer term more capital will be needed to sustain aggressive asset growth and remain compliant with tougher regulatory buffers.
As we expected, the main sources of earnings pressure were: rising funding costs as liquidity further weakened; rapid growth of non-loan credit, which tends to be lower yielding; and slower growth of net fees and commissions. We expect all these trends to intensify in 2013-2014, and be exacerbated by further moves toward interest rate liberalization, which will lift already rising funding costs.
Another critical factor clouding the 2013-2014 profit outlook is Chinese banks' low impairment charges, which have noticeably lagged behind overall credit growth. Loan loss reserves have been rising - reaching 2.8 percent of total commercial bank loans at end-2012 (2010: 2.5 percent) - but this fails to take into account the large and growing portion of new bank credit being extended outside loan portfolios, where reserves are typically nil.
Shifting greater amounts of credit into such channels allows Chinese banks to temporarily maintain low impairment charges and preserve net income, but this comes at the expense of weaker future loss-absorption capacity. Even a modest turn in the credit cycle could result in much higher credit costs than in recent years. The aggregate net profit of commercial banks totalled US$197 billion in 2012, compared with a total stock of bank-related credit of nearly US$14.5 trillion, highlighting how quickly rising credit costs could significantly erode profitability.
Although Chinese banks' performance appears solid by global comparison, headline profit data can be misleading. Subtracting dividends and other charges, growth of retained earnings was below growth in assets and business volume, which were 18 percent and 20 percent in 2012, respectively (the latter figure our estimate). Unable to grow equity to a level commensurate with global peers, Chinese banks remain among the most thinly-capitalized across all emerging markets. This raises the possibility of significant dividend cuts in 2013-2014 and the need for fresh capital injections.
Thin capital, weakening profitability and liquidity, rising exposure to shadow banking, and continued aggressive growth are particular concerns for China's mid-tier banks, and were among the key drivers of our downgrades of ratings of China CITIC Bank, Industrial Bank, and Ping An Bank in February 2013.
The above article originally appeared as a post on the Fitch Wire credit market commentary page at www.fitchratings.com. All opinions are those of Fitch Ratings.
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