China’s largest banks still more shielded from negative shocks

Given the close relationship between the financial sector and the economy, the rebound of growth in 2021 has boosted Chinese banks' profits. Although credit growth has not been very strong lately and banks' interest margins keep shrinking, the fiscal and monetary stimuli announced during the Two Sessions in early March should support loan growth. In this note, we analyze Chinese banks' performance in 2021 and draw implications on future financial health.?

Chinese banks saw a return to profit growth from -2.7% in 2020 to 12.6% in 2021. The rebound was not purely cyclical as total profits are now 10% higher than the pre-pandemic level. Return on asset (ROA) also increased slightly from 0.77% in 2020 to 0.79% in 2021, ending the nine consecutive years of decline. Still, the loan prime rate (LPR) reform has exerted pressure on the net interest margin (NIM), leading to a further reduction from 2.1% in 2020 to 2.08% in 2021. The cost-to-income ratio also worsened somewhat, from 31.2% in 2020 to 32.1% in 2021. Given the above, the higher profits in 2021 come from lower loan provisions and write-offs.?

There were also encouraging improvements in asset quality and solvency. The non-performing loan (NPL) ratio fell from 1.84% in 2020 to 1.73% in 2021, and the stressed loan ratio (the sum of special mention loans and non-performing loans) also declined from 4.41% to 4.04%. Even though bond defaults reached a new high in 2021, Chinese banks seem to have been unscathed from the corporate difficulties in several sectors, especially in real estate. The overall capital adequacy ratio rebounded from 14.7% in 2020 to 15.1% in 2021, above the regulatory requirements. However, a large part of the improvement comes from bond issuance and not organic capital.

The divergence between large and small banks is likely to stay with the fundamental differences in business models, especially regarding asset quality and solvency. Large banks perform better with NPL and stressed loan ratios of 1.37% and 3.21% in 2021, lower than 2.07% and 4.85% for small banks. Large banks also have a much higher capital adequacy ratio of 17.3%, higher than 13.4% for small banks. For the risks related to real estate developers, the loan portfolio for large banks is also safer with a smaller loan book for developers.

All in all, Chinese banks have made significant progress in profit growth in 2021 as the need for loan provisioning and write-offs was lower than 2020. While a decreasing net interest margin and higher costs are bad news, the expected loan growth stemming from the stimulus will help to buffer such negative trends. Furthermore, better asset quality, less exposure to the real estate sector, and adequate capital mean large banks are more shielded from better financial health.

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