Listed Chinese banks confront dilemma: curtail risks or retain profits?

Source:Global Times Published: 2017/4/18 17:03:39

Turning point looms for lenders

China's banking industry experienced head winds in 2016. With nonperforming loans (NPL) soaring, domestic commercial banks were confronted with a tough choice - either prioritize profit growth or allocate capital to hedge against NPL risks. Moreover, many banks have found that their portfolios don't meet regulations. Some experts predict that 2017 will be a turning point for the banking industry thanks to the recovering economy. However, others disagree because cutting overcapacity could undermine the quality of banks' assets.

Photo: CFP

Things may come to a head for China's banking industry in 2017.

The plight of debt-ridden China Huishan Dairy Holdings Co illuminates the deteriorating quality of assets at China's commercial banks.

The dairy producer owes about 40 billion yuan ($5.81 billion) in debt to as many as 70 financial institutions, including 23 banks, financial news magazine Caixin reported on Sunday.

Bank of China has lent Huishan Dairy about 4 billion yuan, making it the company's largest creditor, followed by China Zheshang Bank and Industrial and Commercial Bank of China (ICBC). Huishan Dairy owes the former about 3 billion yuan and the latter about 2.1 billion yuan.

These loans now account for just a fraction of the nonperforming loans (NPL) held by domestic banks.

As of Sunday, 27 listed banks have published their 2016 financial reports, which offer more evidence of Chinese banks' NPL problems.

A banking dilemma

The 27 banks had an average loan-to-asset ratio of 42.16 percent, prompting many of them to boost capital to hedge against the risks posed by NPLs.

In 2016, the Bank of China (BOC) set its loan loss coverage ratio, which measures the bank's ability to absorb potential NPL losses, at 162.83 percent, up 9.5 percentage points from 2015, according to the bank's financial statement issued on March 31.

However, the increase caused the bank's profits to shrink 3.67 percent in 2016 to 164.6 billion yuan. It was the first time the State-owned bank reported negative profit growth since domestic banks were listed.

At a press conference held on March 31, Zhang Qingsong, vice president of Bank of China, explained that the bank increased capital to better manage its risks.

By contrast, ICBC set aside less money to deal with its bad loans. The loan loss reserves ICBC prepared relative to its total bad loans were 136.69 percent, compared with an average level of 176.5 percent among the banking industry. As a result, the company's net profit grew 0.4 percent year-on-year to 278.25 billion yuan in 2016, according to the bank's financial statement published on March 31.

"Interest income is still the main source of commercial banks' revenue," a senior executive at a commercial bank told Caixin. "Although the banking industry has approved large sums of loans in 2016, the interest rate slid."

The executive, who preferred not to be identified, noted that commercial banks have had to choose whether to secure profits or prepare for NPLs. 

"On the one hand, the profit growth rate is the main gauge of performance, so everyone in the industry is afraid of negative profit growth," he said. "But on the other hand, maintaining the stability of the business is important, but that reduces banks' profits."

Investment hiding as credit

Another problem is associated with banks' asset growth model.

In 2016, 23 of the 27 banks that published annual reports have reported double-digit assets-growth rates. In terms of the assets structure, there are eight banks whose investment volume has surpassed that of their credit business.

For example, China Zheshang Bank registered 1.35 trillion yuan in total assets in 2016, up 31 percent. Of those assets, loans accounted for 32.75 percent, while investments, such as bonds or financial products issued by other banks, represented 45 percent.

In addition, more than 60 percent of the Hong Kong-listed Bank of Jinzhou's assets come from investment.

Looking closer, however, most of the bank's investments are categorized as credit, which violates the rules of the China Banking Regulatory Commission (CBRC), the Caixin report said. If the banks strictly followed the CBRC's regulations, they would be trapped in a capital fund "black hole."

Under CBRC rules, China Zheshang Bank is supposed to set aside 1.8 billion yuan to prepare for risks associated with its investments, and Bank of Jinzhou should allocate 2 billion yuan. However, neither has done so.

To make matters worse, most of the banks took a hit during the bond market crisis at the end of 2016, experts said.

For example, the net loss of fair value change of China Merchants Bank amounted to 2.51 billion yuan in 2016, its financial statement showed. The loss was due to "price fluctuations of bonds, precious metals and other derivatives, whose declines far exceeded market expectations," the statement said.

Considering that, a senior executive at Bank of Communication said that the bank would adopt a more cautious attitude in 2017 and cut back on its investments in bonds.

A turning point

Yi Huiman, chairman of the Board of Directors and executive director at ICBC, predicted that the quality of commercial banks' assets would improve in 2017 because the domestic economy has gradually stabilized since the fourth quarter of 2016.

His opinion was echoed in Wuxi Rural Commercial Bank's annual report, which predicted that the NPL ratio would decline slightly in 2017, especially in the Yangtze River Delta region.

However, the report noted that Chinese government's goal of "cutting capacity" in steel, cement and shipping will likely put pressure on the quality of banks' assets.

Therefore, dealing with the mounting debt of State-owned "zombie enterprises" will be a major challenge for the banking industry in 2017, especially considering that credit lines to State-owned enterprises (SOEs) accounted for 10 percent of banks' NPLs.

In 2016, the State Council, China's cabinet, launched a debt-to-equity swap program to help SOEs deleverage and reduce the NPL ratio. But Zhu Xiaohuang, president of China CITIC Bank, said that the program's effectiveness remains difficult to determine.

"Although banks may purchase a large amount of SOE shares, it is hard for them to influence corporate management," Zhu said.

He also noted that if the program is not conducted in a market-oriented manner, NPL ratios may skyrocket in the near future.

The article is based on a report in Caixin magazine.


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