China Banking Circle Confronted with Five Challenges in 2010

As the main source of funds for a package of economic incentive programs since last year, government-directed domestic bank credit exploded in 2009. The amount of credit granted in 2009 was nearly RMB 10 trillion, equal to the total amount of credit in the previous four years. The contribution of capital formation in the first three quarters in 2009 to the GDP growth exceeded 90%, which shows that the flood of credit has made significant contribution to the recovery of China’s economy. However, overly large growth of credit has placed a heavy burden on China’s banking industry. Under the backdrop of structural reform, China’s banking industry will be confronted with a number of big challenges in 2010.
Challenge One: Capital adequacy ratio falling short
Since the flood of loans in the first half of 2009, domestic banks have been suffering from the huge pressure brought about by the capital adequacy ratio. Since the third quarter of last year, the capital adequacy ratio of large domestic banks has been on the decline, especially rapidly expanding city commercial banks. Some national joint-stock banks even neared the red line of 8%.
The third quarter report of last year indicates that except for the Shanghai Pudong Development Bank, all of the other 13 publicly listed banks have witnessed a decline in capital adequacy ratio, with the average drop being 2.43% (compared to the end of 2008).
At present, China has not announced loan targets for 2010. However, since new projects launched in 2009 will enter the construction phase in 2010, the Chinese Government still needs to maintain high lending in order to avoid the abandoning of projects and bad accounts. Ba Shusong, Deputy Director of the Financial Research Institute of the Development Research Center of the State Council, predicts that  between RMB 7 trillion to 8 trillion in credit will be granted in 2010.
 “China’s banks will be confronted with a financing predicament this year the likes rarely seen. Although the amount of credit planned for this year is set to drop by over twenty percent over last year, there is still a heavy burden on the big banks.” Said Cong Yan, member of the expert team of the Sixth Annual Banking Meeting.
If, according to past practice, 40% of credit is granted in the first quarter, the amount of new loans in the first quarter of 2010 will be somewhere between RMB 2.8 trillion to 3.2 trillion, and the average amount of credit extended per month will be about RMB 1 trillion. Therefore, another peak in lending will be upon us.
However, the capital adequacy ratio of banks has lagged behind the explosive growth of loans. As predicted by Chen Ming, an analyst at the Shanghai Office of BNP Paribas, in order to prepare for a new lending frenzy, the banks will need to raise a total of RMB 360 billion in capital in 2010, and this does not include the IPO of the Agricultural Bank of China. The issuing of bonds and shares will each account for half of the funds raised.
Of the five small and medium banks that are short of capital or facing shortages of capital, (estimated for 2010), the Shenzhen Development Bank, China Merchants Bank and the Industrial Bank have already made specific financing plans. After receiving finance, the capital adequacy ratio of these banks will meet standards. The Shanghai Pudong Development Bank and Huaxia Bank are yet to announce financing plans.
Of the four major banks, BOC, CCB, ICBC and the Bank of Communications, the core capital adequacy ratio of the Bank of Communications is 8.08%. With a level below 9%, the bank may have difficulties meeting the requirements for 2010. The third quarter report of BOC in 2009 indicates that by the end of the third quarter, the core capital adequacy ratio of BOC had dropped from 10.81% at the beginning of the year to 9.37%. Capital pressure will restrict BOC’s credit extension in 2010. It has recently been reported by the Hong Kong media that BOC, which stands in need of financing, will refinance by means of an “A+H” share placement. The detailed scheme will be voted on at the general shareholders’ meeting at the end of March, and the amount raised will total at RMB 60 billion. However, the Bank of China has neither confirmed nor denied these reports.
Although the China Banking Regulatory Commission has specified that banks should maintain their “core capital” (mainly equity capital and retained earnings) at higher than 7% of the loan amount, analysts believe that as a measure of protecting banks from the impacts of bad accounts, this ratio might be raised to 8%-9%. This will undoubtedly worsen the financing situation faced by banks.
Challenge Two: Unavoidable increase of NPL ratio
Lending out RMB 10 trillion not only led to a decrease in the capital adequacy ratio of banks, but also brings about other risks in the form of increasing bad accounts. Figures indicate that about 1/4 of the new loans granted in the first nine months of last year were granted to infrastructure projects, whereas 5% went to manufacturing and real estate respectively, which involve higher risks.
Looking at the real estate industry, recent information has shown that the government is determined to regulate the market. This is evident in the expected launch of property taxes, the launch of the evaluation methods for investment real estate and MOHURD taking action to inhibit the growth rate of housing prices. Some banks that have predicted that the real estate market will undergo changes have started to adjust their housing loan policies. They have abandoned the policy of “large scale and low returns” adopted in 2009 in favor of a “small but profitable” approach.
According to Lou Gang, a China strategist from Morgan Stanley, the mainstream demand in China’s real estate industry in 2009 came from investors and speculators, and the real estate industry is becoming increasingly distorted. Lou went on to say that house prices are unlikely to make a soft landing in 2010, and that a huge social crisis is developing.
Industry figures Wang Shi and Pan Shiqi are not optimistic about the prospects of the housing market, holding that “the real estate bubble will burst eventually”. Looking from Japan’s experience, the bursting of the real estate bubble will result in a large increase in bad accounts.
The unprecedented economic incentive program of RMB 4 trillion has unleashed the investment desires of local governments, and this also spells danger for the asset status of banks.
In the first half of 2009, guided by policy and driven by profits, government investment projects were competed for between the banks. Financing of local governments is mainly conducted through financing platforms such as development companies and investment companies established by the governments. Financing modes include borrowing from banks, issuing short-term financing bonds and medium-term notes. According to statistics from the People’s Bank of China, about half of the RMB 7.4 trillion in credit extended by banks in the first half of last year was for project loans of local governments.
Since most of the investment projects of local governments are long-term investments in “railways, highways and infrastructure”, these projects require constant investment on a protracted basis. If loans are ceased, this will result in projects running out of funds and being left unfinished. However, if loans are continuously supplied, there will be a greater risk of inflation and bad accounts.
The ratio of bad accounts in China’s banking industry is not worrying at the present. According to the latest data from the China Banking Regulatory Commission, by the end of the third quarter of last year, both the NPL balance and NPL ratio of commercial banks were continuing to decrease (RMB 504.51 billion and 1.66% respectively).
However, the decrease of NPL balance and NPL ratio is the result of a “dilution” effect by the expansion of credit scale. As estimated by experts, during the decrease of the NPL ratio from 2.40% to 1.66% from December 2008 to September 2009, the total loan balance accounts for seventy percent of the decrease while the contribution of the NPL balance is only thirty percent. That is to say, the expansion of loan scale means that the denominator becomes bigger. So, from a statistical point of view, the ratio of NPLs decreases, but this does not mean the actual risk of nonperforming assets is decreasing.
Although it is impossible to know now how many of these loans will become bad accounts, and despite the fact that bad accounts will not be highly visible in 2010 due to the prospering economy, Chen Ming holds that the loan scale is so huge that an increase in nonperforming loans is simply a matter of time.
Moreover, what is more worrying is that as pointed out by Fitch Ratings in December last year, there are increasing amounts of loan transactions that are not disclosed by China’s domestic banks. Many banks sell packaged loans to investors to spread out risks. However, once these loans become bad loans, a situation similar to the financial crisis caused by subprime mortgage loans in the US will probably arise.
Challenge Three: The “interest margin” profit mode set to end
In the lax credit environment and with the urgent demand for economic growth in 2009, credit business has once again dominated banking business, making it increasingly less varied. The interest margin profit mode on which Chinese banks rely on has become further solidified.
The policy-oriented interest rate cuts at the end of 2008 put a great amount of pressure on the performance of banks in 2009, as this caused the net interest margin to shrink. However, the low interest margin did not continue throughout 2009. Since the third quarter of last year, the net interest margin began to bounce back, and most banks have achieved positive growth.
Taking the new loans in 2010 as RMB 7.5 trillion, some experts estimate that the growth of interest-bearing assets of publicly listed banks will reach 9.12% in 2010. It is probable that the People’s Bank of China will increase the interest rate by 27 basic points in 2010. A conservative estimate is that the net interest margin in 2010 will increase by 5 basic points to 2.40%.
Although the growth of interest margin incomes is encouraging news, it is time that the profit mode of commercial banks was changed. Banks mainly make profits by extending a large amount of loans, but now regulations and restrictions on capital have become more stringent.
According to data provided by Unbank Information, corporate business and credit business are still the major sources of profits for most banks, accounting for over 90% of total income.
At the Guanghua New Year Forum “China Banking Going Global” on January 9, Ma Weihua, President of the China Merchants Bank, expressed that there is a common problem in China’s banking industry: “high interest margin income, extensive management and high costs”. China's banking industry will be faced with the test of transforming its profit mode.
In the contest for credit in 2009, the joint-stock banks came out a lot worse of than the big banks, making the transformation of their profit mode all the more urgent. The Director of the Credit Department of a branch of the Minsheng Bank said: “The supply of homogeneous banking products exceeds the demand for them. Due to severe competition, the banks have lowered their quotations to the minimum. The joint stock banks have lower bargaining capacity when dealing with well-qualified central government enterprises and local state-owned enterprises. Big banks offer 10 markdowns, and we are forced to follow them. We are often forced out.”
Sheng Shengli, Vice President of a branch of the Shenzhen Development Bank in Shanghai pointed out, “Good projects were awarded to the big banks in 2009. There will not be as many good projects this year as there were last year. Small and medium banks are facing the problem of how to making profit. It is imperative that we move away from the interest margin profit mode”.
Cong Yan holds that integration and specialization are trends for the future development of commercial banks. Simply relying on the “interest margin” will not be conducive to long-term development.
Challenge Four: Can green finance break out of the crisis?
The Central Economic Work Conference held not long ago called for the curbing of surplus industries and the promotion of new industries and rural finance. This will mean that most surplus sectors in secondary industries will be unable to get the support from China’s banks in 2010 as they did in the past. After losing their largest client group, commercial banks will turn to new industries and rural finance to seek growth.
Although in the Copenhagen Conference failed to bring results, the concepts of “green economy” and “green finance” have managed to become deeply rooted among the people. Green industries, represented by the low-carbon economy, will no doubt be the main focus of the economic restructuring in 2010.
Since the low-carbon economy accords to the strategy of economic restructuring, China has promised to “cut carbon dioxide emissions per unit of GDP in 2020 by 40-45 percent in comparison to 2005”, and will actively promote the restructuring of industry so as to quickly shift towards a low-carbon economy.
The consequent financial demand will become an important direction the innovation of banking products in the future.
Judging from international experience, the financing of low-carbon industries mainly depends on financing channels like risk investment, NGOs, internal financing, the growth enterprise market and the bond market. This is especially the case in the stage of technical conversion, the early stages of industrialization and in the growing stage of enterprises. Traditional indirect bank financing modes are mainly supplements to the aforesaid financing ways. But this has not stopped China’s banking industry from exploring a new path and launching “green credit”.
Of these banks, the Industrial Bank (IB) was the first mover. Early in 2006, IB cooperated with the International Finance Corporation (IFC) to launch energy-saving and emissions-reduction project loans, and in October 2008, IB announced its adoption of the “Equator Principles”, becoming China’s first “Equator Bank”.
Following a one year period of transition, the first project that applies to the Equator Principles was formally completed at Yongan City, Fujian in December last year. The loan amount of the project is RMB 730 million. IB has incorporated 28 industries, including mining, paper making and shipping, into the scope for application for the Equator Principles, and reviewed the management of environmental and social risks for 219 projects.
By the end of November 2009, IB had granted a total of 187 loans to energy-saving and emissions-reduction projects, with the total amount being RMB 13.737 billion. These projects are expected to save about 8.5178 million tons of coal equivalents, reduce carbon dioxide emissions by 26.8534 million tons, reduce chemical oxygen demand (COD) by 428,200 tons and utilize 472,500 tons of solid waste every year.
Another leading bank in the field of carbon finance is the Bank of Beijing. As of the end of June 2009, the balance of green credit granted by the bank exceeded RMB 4 billion. The total amount of loans granted to China’s energy-saving and emissions-reduction projects in cooperation with the IFC was RMB 133 million, supporting the fields of waste-heat utilization and building energy conservation. These projects cover Beijing, Tianjin, Inner Mongolia, Hebei, Shanxi etc. These projects will reduce greenhouse gas emissions by 540,000 tons every year.
The Shanghai Pudong Development Bank has also made successful progress in carbon finance in July last year. As an exclusive financial advisor, the bank has successfully introduced CDM development and trading agency to two hydroelectric projects in Shaanxi Province whose total installed capacity is nearly 70,000 kW. The bank has secured a competitive trading price for the client. The CER parties have successfully signed an Emissions Reduction Purchase Agreement (ERPA). This CDM project has been successfully registered and signed, and will bring an extra carbon sales income of at least EUR 1.6 million to the client every year.
In contrast, the traditional big banks have been relatively cautious in this field. No material financing agreements have been made as of the present.
Some experts say that compared to infrastructure and manufacturing, carbon finance is a brand-new field for banks. Means of evaluating the return on investment and relative risk control systems still require further improvement.
Challenge Five: Is rural finance nearing maturity?
As China proceeds to adjust its economic structure after the financial crisis, the adjustment of the urban and rural economic structure has inevitably become one of the core subjects again. Rural financing has become the focus of China’s banking once again. Especially, small and medium banks whose room for survival has been occupied by powerful commercial banks are finding it hard to develop in urban markets, and may turn to rural markets by taking advantage of the restructuring in 2010.
“At all times, the problem of lack of guarantees for rural financing has been difficult to resolve. The risks of financing in the country are high, which has caused banks to flinch. On the other hand, rural financing boasts a huge market. Compared with the almost saturated industrial field and emerging industries, competition in the field of rural financing will not be so severe.” Said Fu Wenzhong, Director of the Organizing Committee of the Sixth Annual China (Unbank Information) Banking Conference & General Manager of Unbank Information. Commercial banks should not be passive in the development of rural finance. Social responsibilities aside, there are many “gold mines” in the field of rural financing to be discovered, such as mortgage loans on forest rights and rural household micro loans.
Following up on the original intentions of the CCB, the Agricultural Bank of China acts as the main force in support of rural finance. By the end of October 2009, ABC had issued 30.43 million Jinhui Cards. The number of loan households reached 2.3 million. The balance of granted rural household loans reached RMB 60.5 billion.
“Although rural household micro loans are in favor of ‘agriculture, rural areas and farmers’, they fail to meet the requirements of banks in terms of scale and profits. So, the first thing for medium and large commercial banks to do in the development of rural financing business is to start from big industrialized enterprises.” Said Fu Wenzhong. The banks should start from leading enterprises, learn about the demands of production bases and rural households, and collect relative data during the process for the purpose of innovation of financial products in the future. Alternatively, banks should establish cooperative relationships with upstream/downstream enterprises or inter-partners of the leading enterprises and gradually explore unique modes for the supply of rural financing.
In fact, since the beginning of last year, as advocated by the CBRC, many banks including Minsheng, Huaxia, HSBC Bank and Citibank have successively established village banks. Even big state-owned commercial banks like ICBC and CCB have started to move into the rural market.
According to data from CBRC, by the end of June 2009, 119 new rural financial institutions had opened all over the country, among which 100 are village banks. In plans for 1294 new rural financial institutions over the next three years, 1027 village banks will be opened.
However, Fu Wenzhong pointed out that the current main service providers in the rural financing market are institutions like rural credit unions and village banks which know more about the rural economy than the big banks. So, during the development of rural markets, the big commercial banks should establish organization structures, profit distribution modes and risk control mechanisms especially for the purpose of cooperation with local rural financial institutions, as they are in a position to help them to better understand the market, speed up their extension and avoid risks. (Source: Beijing Business Today)TOP