MarketLine Blog

Rise in non-performing loans potential time bomb for China’s swollen banks

As measured by total assets, four of the ten largest banks in the world are now headquartered in China. As the Chinese economy has swelled, so too have the balance sheets of its largest banks. This has spurred great growth in operating incomes and net profit as demand for credit has soared. However, there are signs that the curse of non-performing loans (NPLs) that wreaked such havoc with the West’s banking system could potentially strike China, a ticking time bomb if left unaddressed, with several economic sectors posing a significant risk.

NPL rates of China's Big Four Banks, 2010-2014


As seen in the figure above, and as addressed in the upcoming MarketLine Case Study “Top ten global banks: An analysis of financial performance, growth opportunities and risks”, China’s so-called ‘Big Four’ (Agricultural Bank of China, China Construction Bank, Bank of China, and Industrial and Commercial Bank of China) are all seeing an increase in the rate of NPLs (A sum of borrowed money upon which the debtor has not made his or her scheduled payments for at least 90 days. A nonperforming loan is either in default or close to being in default).

Industrial and Commercial Bank of China (ICBC’s) rate of NPLs was 0.94% in 2013, but grew noticeably to 1.13% in 2014, while China Construction Bank (CCB) saw an increase from 0.99% in 2013 to 1.19% in 2014. Over the same period, Agricultural Bank of China (ABC) and Bank of China (BOC) saw their rates increase from 1.22% in 2013 to 1.54%, and from 0.96% in 2013 to 1.18%.

This represents a concerning trend for these four part-government-owned institutions as it is increasing the need for allowances/provisions to keep allowances to NPLs ratios healthy. This is eroding net margins (all four banks saw a fall in net profit margin in 2014), causing concern among investors as the country’s dynamic economic growth begins to slow.

While results remain healthy at the moment, they will not if NPL rates continue to increase, particularly as these banks have large (to varying degrees) amounts of unsecured debt, leaving them at the risk of losing significant amounts in the event of defaults.

The banks are realizing this and are making at least some progress with reducing the amount of unsecured debts on their books, but data shows that they must exercise caution when lending to businesses operating in or dependent on the wholesale and retail trade, and manufacturing, as these have above-average NPL rates. These are two of the greatest areas of exposure for the ‘Big Four’ and they must ensure that risk assessment at the point of a lending decision is robust. Any lending must be priced according to the risk involved and the quality of security must be good.

The signs are that the banks are pro-actively taking steps to do this by taking security more often and increasing the margins it charges where the risk necessitates it. They must continue to do this and stay ahead of the curve. Otherwise, reckless lending now could lead to financial disaster tomorrow.

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