Are Chinese banks sitting on a loan tinderbox?

Chinese banks grew heartily in the first quarter, but should they be worried on account of phenomenal debts, in their books, run up by provincial governments? There’s no clear answer yet with state-owned banks posting cheery results, but many analysts fear a ticking loan bomb.

China’s biggest banks posted robust results in the first quarter, benefiting from a rebound in the property market and stable growth in consumer loans. They extended more than 710 billion yuan (Dh423 billion) in mortgage loans in the first three months, more than double the figure in the previous quarter. Consumer loans also surged with credit card lending of the top five commercial lenders soaring a whopping 51 per cent.

The “Big Five” of the banking world — Industrial and Commercial Bank of China, China Construction Bank, Bank of China, Agricultural Bank of China and Bank of Communications — managed to beat market expectations and posted profit growths ranging from more than 8 per cent to 15 per cent in the first quarter from increased interest and non-interest income. Their capital adequacy ratios, which is a bank’s capacity to cushion potential losses of capital, too remained in the healthy zone.

Market watchers, however, refused to be effusive about these impressive results, saying they do not reflect the sector’s true health and profitability. The heavy reliance of banks on net interest income makes foreign analysts and rating agencies wary. They fear that profitability may be hurt in future with regulators pushing harder for interest rate liberalisation. Fierce competition will inevitably shrink net interest margins for individual banks, making the sector’s high growth unsustainable in the long run.

Hidden danger

More worryingly, the non-performing loan ratio of the biggest banks is rising, albeit imperceptibly, therein hiding a financial tinderbox. The NPL loan ratio increased in the first quarter to 0.99 per cent and by the end of March, outstanding NPLs stood at 524.3 billion yuan — up by 20.7 per cent year-on-year.

Bank loans grew almost 60 per cent in China in 2009-2010, after the government announced a 4 trillion yuan stimulus package to keep the economy moving during the global recession. Much of this routing took place through bank loans made out to local governments which then went on a spending binge on infrastructural projects.

Flooding the economy with trillions of yuan in new loans did help China maintain high growth rates, but now, the debts are coming home to roost. The National Audit Office (NAO) announced that local debts include 6.71 trillion yuan directly owed by local governments, 2.34 trillion yuan borrowed by enterprises and public institutions and guaranteed by local governments and 1.66 trillion yuan owed by independent enterprises and public institutions that local governments took the responsibility of bailing out.

With such massive burden on local governments, the China Banking Regulatory Commission sounded an alarm to commercial lenders, warning that they should carefully monitor the loans extended to entities called “local government financing vehicles”. These LGFVs were set up by local governments to invest in infrastructure and other ambitious projects and about 35 per cent of debt owed by these financing vehicles is set to mature between 2012 and 2014. In the light of the risks posed by local government borrowing to the national economy, two reputable US rating firms lowered their credit ratings for China last week.

The panic, however, is yet to set in because commercial banks are fundamentally strong in China and will not be destabilised by bad debts immediately. Also, Chinese authorities are willing to do anything to stave off mass defaults by government-related borrowers.

Alternatives

Unwittingly, the debt bomb has opened up new avenues for funding. Local governments remain in need of funds as they are under pressure to continue with their urbanisation projects. With bank loans getting out of reach, many are turning to the private sector for alternative funding, thus reducing the demand on banks.

A private company, China Pacific, is one of the innovative firms involved in more than 500 public projects nationwide through a “build-and-transfer” model, a form of project financing where a private entity receives a concession contract from the government to finance, design, construct and operate a public facility. The private investor recovers its investment by payment in instalments from the government from the operating income of the project.