Chinese banks’ asset quality so far under control but with credit risk polarization

This is the first report of the China Banking Series 2021.

In the aftermath of the Covid-19 pandemic, Chinese banks are facing an ongoing and amplified Catch-22 dilemma. As China speeds up the pace of financial opening and extends its geopolitical arm’s length, the development of its banking sector is important for domestic and foreign investors. In the first note of NATIXIS China Banking Series 2021, we analyze the performance of Chinese banks focusing on asset quality.

Thanks to the quick economic rebound, the decline in banks’ profitability is relatively mild in China comparing to global peers. Net income growth of Chinese banks decelerated from 6.9% in 2019 to 0.7% in 2020, but still outpaced -44% for the rest of the world. A large part of the downshift can be attributed to loan provisioning. With carrots and sticks from policy makers, Chinese banks have written off 0.7% of total loans in 2020, which is higher than the 0.45% for global peers.

With faster loan growth and a rather aggressive write-off policy, the stressed loan ratio fell from 4.8% in 2019 to 4.2% in March 2021 even if its absolute amount kept growing. Despite the fallout of Baoshang Bank and the government bond issuance to support the merger of 12 troubled banks in Liaoning, the overall asset quality remains under control in the banking sector. But the stressed loan ratio may not provide a full picture of Chinese banks’ credit risk. A timely measurement on asset quality can be found in the bond market, which shows bond issuers have delayed more repayments and the polarization of credit risks among different types of ownership, sectors and provinces.

If 2020 marks the beginning of changes, the first and foremost is on state-owned enterprises (SOEs). Regulators seems to have a higher tolerance on bond defaults by SOEs to change the perception of implicit guarantee, especially with the drama of Huarong Asset Management Company. That said, banks may be asked to make concessions for the sake of financial stability. For private firms (POEs), regulations aiming at containing financial risks have increased their repayment pressure. Real estate developers, which are largely privately owned, are at the eye of the storm forming 31% of onshore bonds with repayment pressure so far in 2021. Still, the pressure is concentrated in a few provinces, such as Hainan, Liaoning, Hubei and Tianjin. In the same vein, local governments with less fiscal space may face higher difficulties in supporting the firms in their own provinces.

Whatever comes next, there will be credit polarization not only among and within SOEs and POEs, but also across sectors and provinces, i.e. the best becomes better, the worst becomes worse. Against such backdrop, we expect Chinese banks to continue the rapid loan write-off and asset securitization. This means that heightened credit risk in the aftermath of the pandemic will be shared by the rest of the economy.

Full report available for NATIXIS clients.