Chinese banks weigh asset quality risks as regulator urges cut in loan buffers

China’s banking regulator is encouraging lenders to cut bad-debt buffers, even as a lending push and an economic slowdown raise concerns about asset quality.

The China Banking and Insurance Regulatory Commission, or CBIRC, is pushing banks to step up lending to help the country’s pandemic-afflicted economy. Through a series of conferences and guidelines since early May, it urged banks, especially the large ones, to cut their provision coverage ratio to free up liquidity for lending. The provision coverage ratio, or PCR, refers to the percentage of funds banks set aside as a buffer against potential bad loans.

“It’s a trade-off between short-term asset quality versus a mandate to support the economic recovery,” Gary Ng, a senior economist at Natixis, told S&P Global Market Intelligence at a June 7 event. Chinese banks need to take more responsibility in channeling liquidity and stimulating the economy amid a zero-tolerance policy for COVID-19, Ng said.

Large state-owned banks and joint-equity banks reported an average PCR of 245% and 210%, respectively, at the end of the first quarter of 2022, according to People’s Bank of China data. The PCR at Postal Savings Bank of China Co. Ltd. stood as high as 414%, while Bank of China Ltd.’s was 187%.

Postal Savings Bank of China and Bank of China did not respond to requests for comment from Market Intelligence.

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Bigger buffers

Chinese banks have increased their coverage ratios over the years, especially since 2018 when the new accounting standard IFRS 9 was adopted, according to Cheng Xi, director, financial institutions ratings at S&P Global Ratings.

While the ratio may come down over time for megabanks and good quality lenders, Cheng expects the impact on asset quality to be “manageable” as the guideline implies they still need to stick to the minimum regulatory requirement of between 120% and 150%. The reductions would also be applied only to banks with relatively high provision ratios.

The world’s second-largest economy is seeking to boost recovery as the recent wave of COVID-19 infections in Shanghai and Beijing abates. Apart from the central bank’s easing measures that include cuts to policy interest rates and reserve requirement ratio, the CBIRC’s push could release additional funds for banks to lend. The government’s targeted GDP growth of 5.5% this year is threatened by lockdowns in the two biggest financial centers to control infections. The economy grew 4.8% in the first quarter, compared with 18.3% in the same period last year.

Chinese banks’ nonperforming assets, which include debt instruments such as bonds, are estimated to rise to 6.5% of total loans by the end of this year from 6.0% at the end of 2021, with loans to small businesses being most vulnerable to stresses such as lockdowns and commodity price inflation, according to Ratings. Problem loans, defined as those that can potentially turn bad, including nonperforming assets and special mention loans, are creeping higher, CBIRC data showed.

The impact of the PCR easing on banks’ financial health will show up in the next one or two years, especially if the additional lending “goes to a bunch of zombie companies,” Ng said.

Striking a balance

The authorities are seeking to find balance between risk and the need to spur the economy. “Preventing financial risk will be the target of next round of policy movements,” Pan Gongsheng, deputy governor of the People’s Bank of China and director of the State Administration of Foreign Exchange, said at a June 2 press conference. The central bank wants to promote “market-oriented and prudent operations” among lenders, Pan said.

To be sure, a lower PCR won’t necessarily “encourage more lending as that depends not only on banks’ ability to lend but also the willingness of the borrower,” said Chen Dong, head of Asia macroeconomic research at Pictet Wealth Management. The general demand for loans is very low currently given the unclear macro outlook, Chen added.

Credit demand remains sluggish due to lack of confidence in the real estate and consumer sectors. Housing sales continue to slow amid uncertainty over the country’s repeated COVID-19 lockdowns, requiring stimulus measures by the government.

“The key issue facing the government is to bring confidence back and allow the economy to recover,” said Alexandre Tavazzi, chief investment officer Asia and head of CIO office and macro research at Pictet Asset Management. Once that happens, credit demand, especially at the corporate level, would return, Tavazzi said.

The push to reopen the economy and boost lending can help banks’ loan volumes as well as quality, according to Credit Suisse. New loans could show decent recovery in June after the weakness of the previous two months as income recovers in the household and corporate sector, leading to improved debt servicing capability for banks, Credit Suisse analysts said in a May 31 note.

“June could be a turning point for credit demand as easing policies filter through and businesses gradually resume,” said Wang Yifeng, Beijing-based banking analyst at Everbright Securities. Still, the property sector and small-to-micro businesses will remain the major sources of bad loans for the rest of 2022, Wang added.

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