China’s top bank regulator sees surge of bad loans straining financial system in 2020, 2021

Frank Tang
·5-min read

China’s top banking regulatory official said on Thursday that the country’s banks have to deal with 3.4 trillion yuan (US$489.5 billion) worth of non-performing loans in 2020 – flagging a big risk for the banking system in the world’s second-largest economy.

The total marks a hefty increase from 2.3 trillion yuan in 2019, and the value of bad loans could be even higher in 2021.

Guo Shuqing, chairman of the China Banking and Insurance Regulatory Commission, said in an interview with the official Xinhua News Agency that the increase in non-performing loans (NPLs) – loans in default or close to default – will put huge pressure on the country’s banks, especially small and regional ones.

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“As many loans are rolled over [in 2020], some problems will only emerge next year,” Guo was quoted by Xinhua as saying, adding that a rebound in bad loans is “inevitable” since the coronavirus shock has adversely affected so many companies.

China warned to prepare for ‘big rise’ in bad loans as financial system braces against coronavirus

The warning by Guo, who is also the Communist Party secretary at the People’s Bank of China, came at a time when many of the country’s small banks are facing a moment of reckoning after years of undisciplined balance sheet expansion, as well as instances of fraud and corruption.

Meanwhile, Guo said, Chinese banks have improved their loan structure – with more lending going toward manufacturing, infrastructure, technology and small businesses.

Guo added that Chinese banks are now being told to enhance their support of small businesses. In addition, he said he will encourage banks to invest more in corporate bonds.

According to official statistics from Guo’s agency, the NPL ratio in China was among the lowest in the world. The ratio for Chinese commercial banks rose 0.03 percentage points in the second quarter to 1.94 per cent at the end of June.

But hidden bad loans, if exposed, could easily wipe out bank profits and erode capital bases. In the first half of this year, the combined profits of Chinese banks dropped for the first time in more than a decade – falling 9.4 per cent to 1 trillion yuan in the first half of the year, government data shows.

China new bank loans fell in July, but broad credit and liquidity growth quickened

In one example, Baoshang Bank, based in Inner Mongolia’s Baotou city, had not published any annual reports since 2016, and was taken over by authorities in May 2019.

After more than a year of checking, China’s central bank found that the bank’s financial data had been fabricated, and the bank had to file bankruptcy – marking the first bank failure in China in more than 20 years. In insider trading alone, the bank had lent 156 billion yuan (US$22.5 billion) worth of loans to its controller – the Tomorrow Group, owned by tycoon Xiao Jianhua – and all of the loans had become “non-performing”, according to an article published by Zhou Xuedong, the head of the takeover team at the central bank.

The Chinese authorities also stepped in to bail out Hengfeng Bank last year.

At least four bank runs were reported in China this year – all at small regional lenders. The NPL ratio at rural commercial banks was 4.22 per cent even by China’s official statistics.

Mergers of small banks, often directed by local authorities, are becoming more frequent. For instance, Panzhihua City Commercial Bank and Liangshan Prefecture Commercial Bank in Sichuan province announced in June that they would merge into a new entity.

The reform of small and medium-sized banks is key to improving the soundness and stability of the overall financial system

Guo Shuqing

Five local banks in northern China’s Shanxi province – Jinzhong Bank, Jincheng Bank, Yangquan City Commercial Bank, Changzhi Bank and Datong Bank – are also expected to merge into one bank. The merger proposal will be discussed at a temporary shareholder’s conference in late August, according to bank notices released last week. Yangquan City Commercial Bank reported a bank run in mid-June.

However, concerns remain about China’s small banks.

Raymond Yeung, chief Greater China economist at ANZ Bank, said small banks, often owned by local authorities, are particularly exposed to the risks of bankrolling pet projects of local governments and state enterprises.

“A bigger size will generally help diversify risks … But it’s more important to improve asset quality through business restructuring and bad-asset disposal,” Yeung said.

In the Xinhua interview, Guo vowed to replenish the registered capital of small banks, broaden the scope of capital for risk disposal, and improve corporate governance.

“The reform of small and medium-sized banks is key to improving the soundness and stability of the overall financial system,” he added.

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