Figuring
out the health of Chinese banks is a blind man's game, but the risks to the
sector are unmistakably piling up.
By Katherine Ryder, contributor
FORTUNE -- It's a familiar story to Americans,
but now it may be unfolding in China.
From 2008-2010, China's largest banks made
scores of loans to local governments and state-run companies. Exports had
fallen in the wake of the financial crisis, so the government wanted to create
jobs and boost local demand. As a result, developers erected high rises and
shopping malls across the country and the Chinese economy grew at roughly a 10%
clip. But some analysts and ratings agencies assert that lending standards weren't
strict enough. Too many bad loans were made, they say. Financial reform didn't
come fast enough.
Last week, Liu Mingkang, the chairman of the
China Banking Regulatory Commission, announced that a recent round of stress
tests proved that Chinese banks could handle up to a 50% drop in property
prices. Banks, which fund themselves mainly through deposits, are growing their
profits at 20% per year. Though the economy appears to be slowing, it is still
estimated to grow around 9% this year, which could theoretically offset any
losses incurred by bad loans.
Liu may well be right, at least in looking at
the sector over the long term. Though some analysts balk at the lack of stress
in the stress tests, the Chinese central bank essentially backs all deposits.
Banking in China is still in its infancy, with huge upside potential. Few
consumers use credit cards yet, which represents a major opportunity for
financial institutions. And as China tightens its monetary policy, lending
margins are tilting even more in favor of the banks.
In the near-term, however, the bears may win
out. Three areas of concern stand out. The first is China's overly managed
interest rate policy: Banks are only allowed to offer its customers a maximum
3.5% interest rate on one-year deposits. With China's inflation rate currently
above 5%, Chinese companies and consumers investing in banks face the prospect
of a negative real savings rate.
Three
areas of concern
As a result, companies that want better rates
of return are looking at trust companies, which are unregulated and have caught
the wary eye of Chinese authorities, particularly as the government has
attempted to cool the countrys supposedly overheating property market. The
China Securities Journal reported that trusts invested about RMB 207.8 billion
($32.4 billion) in the property market in the first half of the year. The rate
at which they're lending is upward of 20%, compared to the banks' 6.7%, a rate
at which it is easier to roll over bad loans.
The extent to which these trusts will have a
major effect on the health of the Chinese banking industry is a major area of
disagreement between China's bulls and bears. The bulls say that trusts
represent healthy interest rate competition, a way for corporations to put
pressure on regulators to liberalize interest rate policy. The bears argue that
trusts are an example of excessive credit in the aftermath of years of reckless
lending, both of which will come back to haunt the Chinese economy over the
next few years.
Another source of worry is China's Asset
Management Corporations (AMCs), which present more measurable off-balance-sheet
loan risk. In the late 1990s, the Chinese government needed a place to dump bad
loans left over from the Asian financial crisis. AMCs were created to serve
this purpose. But in 2009, instead of paying off the rest of the debt, the
government rolled over all the AMC bonds another ten years. The depth of the
potential losses in these vehicles remains unclear.
A final source of concern is the continued use
of collateralized lending. Much of this collateral is typically in the form of
land or property. In an economic downturn, Chinese banks might face liquidity
issues, says Jason Bedford of KPMG, a consultancy.
All the same, Bedford thinks the fears about
the bad loans lurking off the balance sheet are overblown. "I'm getting
one or two phone calls per week from overseas asking me about this topic,"
he says, specifically referring to a July report in which Moody's (MCO) said the Chinese government may have
underreported loans made to local governments by half a trillion dollars.
Bedford says his own analysis doesn't support some of the claims in Moody's
report, particularly those relating to credit risk.
And herein lies the problem in assessing
Chinas banks: figuring out whose data to trust. The Chinese banking system
trades disproportionately with itself, and much of the critical information
about bank stability is colored by the data sources. There are so few foreign
companies trading within China's capital markets that critical pieces of data
can never be corroborated. No one knows whether asset prices are accurate,
whether banks liabilities are accurately reported, or even the true depth of
the lending market.
The only way to judge, then, is by examining
it all -- banks' financial statements and information from national statistics
bureaus, keeping in mind the motivations of the ruling party. Though the
Chinese government is terrified of systemic risk, it also needs to control its
banks in order to promote its ultimate vision of a harmonious society. This
cause presents risks of its own.
A recent report from
Roubini Global Economics says the most critical concern for Chinese banks is
the recent deterioration of credit standards, but that a major side concern is
the state's refusal to stop using the commercial banking sector as its personal
piggy bank.
Though China's banking system has undergone
decades of rapid and impressive growth, underlying cracks are starting to
appear. China may have learned from America's mistakes, but it will inevitably
make some of its own.
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