By Mike Bird
As China's recovery from the pandemic continues, the burden of the country's economic support measures is increasingly falling on its commercial banks.
Financial institutions extended 1.6 trillion yuan (about $232 billion) in new credit to manufacturers in the first seven months of the year, already more than twice the amount lent out in all of 2019. The enormous increase in lending will provide valuable help in keeping struggling businesses afloat, but the obvious risks associated with the surge in loans is largely being carried by major lenders, who will deal with the consequences for years to come.
Looking at the reported asset-quality metrics that major Chinese lenders will report in their upcoming interim results isn't a useful way of interpreting their current or future challenges.
Even disregarding the political incentives that make it more difficult for banks to recognize delinquencies by state-owned enterprises, small and medium-size institutions benefit from a moratorium on loan repayments until March 2021. As a result, it is somewhere between difficult and impossible to tell which may be beyond the capacity of their borrowers to repay.
The scale of loans under the moratorium helps contextualize the real scale of official support available to banks. China Banking Regulatory Commission chairman Guo Shuqing said in an interview in the middle of August that 2.46 trillion yuan in small business loans alone were covered by the moratorium scheme. In June, the People's Bank of China pledged to assist commercial banks by buying 400 billion yuan in unsecured small and micro enterprise loans.
Not only is the amount small relative to the scale of the lending which may sour, but the PBOC also insisted that it wouldn't cover credit risk associated with the loans, which commercial banks are obligated to buy back after a year.
Although official interest rates are still high by the standards of most of the world, ongoing changes in China's approach to its benchmark interest rates will also eat into bank income. According to Pantheon Macroeconomics, the proportion of loans priced at or below the loan prime rate has risen to 30% as of the end of the second quarter, up from 27% in March and 16% a year earlier. Rates on deposits, on the other hand, have hardly budged, squeezing the spread for lenders.
Given the limits of official assistance, two simple truths are best to keep in mind: Firstly, much of the fresh credit extended would be unlikely to pass the banks' pre-pandemic lending standards. Secondly, Chinese state banks' returns on both assets and equity were already in a state of secular decline even before the new demands made of them by coronavirus.
The major banks are well capitalized, and the risk is to profitability, not solvency. Such banks are required to apply political and social objectives to their lending to a greater degree than truly commercial institutions, but with relatively limited support from the central bank.
Valuations have plumbed new depths, with the major four lenders now priced at between 0.35 and 0.5 times their book value. Even that may still be too high given the challenges ahead.
Write to Mike Bird at Mike.Bird@wsj.com
