Chinese banks are facing increasing risks as concerns grow over rising non-performing loans (NPLs) and declining returns. These concerns have made Chinese banks a focal point for investors worried about the country’s economic prospects. The banks’ exposure to local government financing vehicles (LGFVs), which fund infrastructure projects for local governments, as well as the crisis-hit property sector, has led to significant drops in their share prices. In response to the selloff, the authorities have taken steps to stabilize the market.
Goldman Sachs recently downgraded several major Chinese lenders to Sell ratings, causing the Hong Kong-listed banking sector index to plummet over 10% in just three sessions. However, the state-backed Securities Times has criticized Goldman’s report, calling it based on pessimistic assumptions and highlighting a misinterpretation of the situation.
While the risk of a crisis arising from LGFV debt is considered low by sell-side analysts, Chinese banks are still likely to face challenges from rising NPLs and decreasing returns. If the revenues of local governments continue to worsen, NPLs among Chinese banks may increase, leading the banks to bear the cost. This could impact earnings growth, capital accumulation, and dividend payouts.
China’s banks have seen their net interest margins decline over the past decade, while their price-to-earnings ratios have dropped. Goldman downgraded Agricultural Bank of China (AgBank) to Sell and Industrial and Commercial Bank of China (ICBC) and Industrial Bank to Sell from Buy. However, the low valuations of these banks suggest that share prices could rise in the future.
Morgan Stanley analysts have also weighed in on the situation, noting that China’s banks have been consistently managing risks. They highlight that LGFVs, being quasi-government entities, are unlikely to follow a model of bankruptcy and write-offs to avoid systemic risks. With the potential for tax advantages, lower risk weighting for capital provisioning, and the possibility of using LGFV debt as collateral for central bank funding, banks are willing to take on more of this type of debt.
Goldman estimates that China’s six largest banks account for $4.2 trillion of local government debt and have the capacity to take on more. The cushion of tax and capital savings is expected to limit the decline in return on equity for these banks, forecasting a healthy ROE of 12.5% in 2023 and 11.9% by 2025. These ratios surpass those of many banks in the United States and Europe.
While concerns about Chinese banks persist, the authorities are closely monitoring the situation to mitigate systemic risks. The central government has a deep understanding of the debts’ size and weak links, reducing the probability of widespread defaults. Despite the challenges faced by Chinese banks, analysts believe that the risks posed by LGFV debt are manageable and unlikely to lead to a crisis.
In conclusion, Chinese banks are currently grappling with increased risks due to rising non-performing loans and diminishing returns. Market concerns about their exposure to LGFVs and the crisis-hit property sector have led to significant drops in their share prices. However, experts believe that the risk of a crisis stemming from LGFV debt is low. While Chinese banks will likely face challenges in managing NPLs and maintaining profitability, they are expected to weather these difficulties and continue to play a significant role in China’s economic growth.
