Despite the odd splutter, China’s leading banks have had much to cheer about over the past few years. Multi-billion-dollar stock market listings, improvements in their balance sheets and a strong upturn in profitability mean that these banks are no longer the basket cases they once were.
Last year, in particular, was as good as any for most Chinese banks, according to Fitch Ratings, buoyed up by acceleration in loan growth, record earnings, and diminishing bad debt portfolios. In August, China Merchants Bank became the first Chinese bank to achieve an individual rating above D from the ratings agency when it was upgraded to C/D. The individual rating reflects a bank’s creditworthiness on a fully standalone basis. Although a C/D rating shows there’s room for significant improvement – after all the highest possible rating is A and the lowest is F for failed – at least it demonstrates that China Merchants Bank is on the right track. Fitch believes that other leading Chinese banks might get their individual ratings upgraded this year.
If they do, it will be against a much less supportive backdrop. Uncertainty about a possible US recession is one issue but of more concern is the increasingly delicate state of China’s economy. Since last year, the authorities have taken various decisions to try to rein in inflation, which is at a 12-year high. The central bank has raised interest rates six times and increased banks’ minimum reserve requirements on deposits to 15%, an all-time high. The government has also capped the amount of new loans that Chinese banks can make this year to last year’s levels.
These policies could hit the banks in two ways. First, further tightening of monetary policy will mean lower growth of net interest income, the main way that banks make profits. The other issue is that a clampdown in lending means that it will be tougher for high-growth companies to continue developing at the same pace as before. For this reason another ratings agency, Standard & Poor’s, reckons that Chinese banks could face higher non-performing loan ratios, especially from corporate borrowers, for the first time in five years.
Although S&P reckons a large-scale deterioration in loan quality is still some way off, it will not take much to dent confidence in a banking system that has required $500 billion in bailout packages from the government over the past few years. Banks’ risk management capabilities have improved but they are still a long way from reaching the required standard. Lack of accurate data and experienced credit officers as well as corruption are just a few of the shortcomings. The banks need to develop a greater awareness of credit and market risk so that it becomes ingrained in their culture. This will be no easy task given the sheer size of these institutions. The task will become even more complex as they continue to undergo rapid change.
China’s banks can no longer rely on a favourable environment. A rockier road lies ahead.