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Equity ratio policy spurs concerns

CHINA'S decision to pare the equity capital requirement of fixed-asset investments is expected to fan record growth in borrowing, stirring concern about a deterioration in credit worthiness, analysts said.

Some banks, sensing what may turn into a squeeze on their profits, are hedging their risk by reaching out to smaller borrowers and retail customers, according to analysts.

The State Council on May 27 detailed cuts in the equity capital requirement ratio, largely to benefit infrastructure projects that are at the heart of the nation's 4 trillion yuan (US$586 billion) economic stimulus plan.

"The lower requirements for infrastructure-related investment projects mean more money will now come from bank loans," said Li Wei, a Standard Chartered Bank economist.

The equity requirement for railway, road and metro projects was lowered to 25 percent from 35 percent, while the ratio for airport, port and inland shipping construction was lowered to 30 percent from 35 percent.

Banks in China have been in the economic spotlight in recent months, extending 5.84 trillion yuan of new loans in the January-May period. Credit in the first five months already surpassed the central government's target of 5 trillion yuan in new lending this year.

The strong surge in credit was attributed to banks scrambling to finance infrastructure projects supported by the central government. The easing of capital requirements may help to fuel the rise of similar projects by provincial and municipal governments.

Lu Zhengwei, a senior economic at the Industrial Bank, said local initiatives should prompt a second rush of lending between June and August.

Still, growth of new loans slowed in April and May compared to the pace in the first quarter. Lending fell to 591.8 billion yuan in April and 664.5 billion yuan in May from a monthly average of 1.6 trillion yuan in the first quarter.

Standard Chartered's Li said that he suspects higher capital ratios served as a barrier to local government projects and helped produce the April slowdown. The new capital ratios have taken effect since May 27. "With these equity capital constraints lifted, banks will likely resume lending," he said.

Standard Chartered Bank expects total new loans to top 8 trillion yuan this year, with continued demand for loans throughout the rest of this year.

When the Chinese government announced its 4 trillion yuan stimulus package in November, an increase in credit growth was widely expected, but analysts hadn't forecast such a sharp rise in the first quarter.

Fitch Ratings said the rush of borrowing was driven by an easing monetary environment, shrinking interest margins and the implicit assumption that losses related to stimulus lending will be covered by central or local governments.

Against the economic slowdown, Chinese banks have been aggressively increasing loan volumes to offset smaller margins.

The surge has some analysts worrying about a return to the 1990s, when Chinese banks went on a lending spree to often less than creditworthy state companies, only to get saddled with a mountain of bad debt that forced the government to bail out its biggest lenders years ago ahead of initial public offerings.

"It is of concern that this emphasis on short-term profit (through oversupply of credit) may be contributing to excessive risk-taking by banks, particularly in corporate lending, which could lead to material losses in these portfolios," Fitch said in a report.

Although new loans in the first quarter more than tripled from a year earlier, interest revenue earned by listed Chinese banks fell 3.1 percent.

The People's Bank of China, the central bank, cut official interest rates six times since September to shore up the economy, eating into banks' margins.

Still, results for 2008 and the first quarter of this year showed the Chinese banking industry holding up relatively well, especially when compared with overseas counterparts stung by global recession and excessive risk-taking. But that trend is clearly changing.

Net income of China's 12 listed banks has remained in positive territory, but growth of net income in the first quarter declined 8.1 percent from a year earlier.

The infrastructure-dominant nature of recent lending and the shifting focus of lending toward large, state enterprises has helped push down profits, since infrastructure borrowers typically receive loans at below the base interest rate.

Some banks are trying to trim dependence on large state corporations by diversifying their loan portfolios.

The Bank of Communications expects loans to smaller clients to rise faster than its average loan growth this year, said Qian Wenhui, executive vice president of the fifth-biggest bank in China.

Qian, who declined to disclose the bank's loan targets, said margins on loans to smaller businesses will help improve profitability.

The Shanghai-based bank earlier this year set up a team solely dedicated to smaller clients. The bank said it now has more than 30,000 smaller business clients, which account for more than half of its outstanding loans.

Smaller lenders are following suit. Shenzhen-based Ping An Bank is setting up a small business credit center in Shanghai last Thursday to penetrate deeper into that segment.

At the same time, March retail lending showed signs of new life as residential properties strengthened and the government pushed to increase consumer credit.

In mortgage lending, banks are singling out creditworthy individuals willing to sign up for long-maturity loans.

"We see it as a good trend to follow and we expect retail lending to accelerate further in the months ahead," said Zhu Tao, vice president of the Shanghai branch of the Bank of China.


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