Industrial Commercial Bank of China (ICBC), the largest state-owned bank in China, has broken through the half-a-trillion dollar Tier 1 capital barrier for the first time since The Banker began its benchmark Top 1000 World Banks ranking in 1970. It remains the largest bank in the world, a position it has held for a decade.
The other three Chinese megabanks – China Construction Bank, Agricultural Bank of China and Bank of China – have also retained their spots at the top of the ranking behind ICBC, so all is good at the top for banks in China. Based on these results, banking in the country seems robust.
In the People's Bank of China's (PBOC) annual financial stability report, released in September 2021, just three out of 30 medium-to-large domestic banks were not able to meet minimum regulatory capital requirements in the instance of a severe economic downturn. A year previous, 21 failed a severe stress test and a further nine failed a moderate stress test. Therefore, the country's banks are in better shape today than they have been before.
In a note released at the time, Fitch stated: "We believe state banks and large joint stock commercial banks would continue to maintain capital well above the minimum requirements despite a probable economic slowdown from 2022."
However, a different story is beginning to emerge. Nicholas Zhu, vice-president and senior credit officer at Moody's Investors Service, says: "The China Banking and Insurance Regulatory Commission's (CBIRC's) first-quarter data looks weak for bank performance, mainly in profitability, and looks likely to continue into the second and possibly even third quarter.
"We still have a stable outlook for the Chinese banking system this year, although the data moderated our view to highlight downside risks," he continues. "We downgraded 2022 gross domestic product growth [from 5.2%] to 4.5%. This softening of expectation is likely to guide us into the second half of the year."
However, trouble is brewing with the many smaller banks across the country. Many banks have felt some pressure from the turbulent property sector (see page 50), but it is the smaller banks, with less ability to absorb the shocks, that are the most impacted.
Vivian Xue, director of financial institutions at Fitch Ratings, says: "Due to limited direct exposure of Chinese banks to property development loans, we've seen a modest impact on reported non-performing loans (NPLs). But because the smaller banks have high exposure to more vulnerable borrowers and risky sectors, their asset quality may be more susceptible to macroeconomic volatility. We do not forecast a sharp increase in bank impairment charges in 2022, as banks have already resolved a large number of NPLs in recent years, and there is decent collateral coverage to cushion potential impairment."
At the end of 2022, total NPLs were valued at Rmb2.85tn ($425.91bn), with the biggest increases recorded among city and rural banks. The PBOC found 422 financial institutions to be high-risk; however, this accounts for only 1.36% of total banking sector assets. The NPL ratio for China's state-owned banks was 1.45%, while among the 12 joint-stock banks it was 1.42%. The pressure is concentrated on the smaller city and regional banks, which do not have the protection of being considered among the country's 19 systemically important banks.
On the release of the data, PBOC's head of the financial stability department, Sun Tianqi, said that banking sector risk still exists and it is concentrated in the regions. "A small number of provinces have a high concentration of high-risk institutions, and we still need to focus on banking sector problems triggering a domino effect," according to Mr Sun.
Chan Kung, founder of China-based think tank Anbound, agrees: "The small and medium banks are already facing difficulties, especially in rural areas — those village and town banks. For bigger banks, the performance has not been so bad. The number of NPLs looks depressed."
The risks in the regions were brought into sharp relief by a run on the banks in Henan province earlier this year when cash withdrawals were suspended from four institutions during April 2022. The CBIRC stated that Henan New Fortune Group, the largest shareholder of the four banks involved, was "suspected of raising funds illegally using online channels and third-party systems in collusion with bank insiders". Account holders are protected up to Rmb500,000 of their deposits if their bank is in difficulties.
The CBIRC is currently pushing banks to cut bad-debt buffers. Large institutions, in particular, have been told to cut their provisions coverage ratio to free up liquidity, although they are expected to remain within the minimum regulatory requirement of 120% to 150%.
"Chinese banks' non-performing 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% at the end of 2021, with loans to small businesses being most vulnerable to stresses such as lockdowns and commodity price inflation," said S&P in a note released in June 2022.
Harry Hu, senior director at S&P Global Ratings, believes the NPL situation is worse than stated. "Officially, the NPL in 2021 is 2.6%, but we think it is double that at around 5.5%," he says. "The banking sector is likely to realise this increase during 2022 due to delays in reporting this stress."
Using the agency's own metrics, Mr Hu believes there will be a sizeable sum of defaults during 2022. "We forecast there will be $1.1tn in forborne loans this year. These are stressed loans that are largely classified as 'normal' which we capture with the non-performing assets metrics, on top of the official low performing loans metric," he explains.
According to Alicia García-Herrero, chief economist for Asia-Pacific at Natixis, "NPLs have not seen a relevant increase during the pandemic, which is somewhat strange, but the reason is that banks are quite shielded from the worst companies, which go to the bond market for issuance, especially offshore. This is particularly the case for riskier companies and higher yield companies."
However, there is confidence among the banks in their ability to withstand the NPL levels. Ping An Bank saw its NPL value and ratio decline during 2021. It reported that NPLs dropped by Rmb115m during the year, while the NPL ratio improved by 0.16 percentage points to 1.02%.
Jin Yu, chairman of the Bank of Shanghai (BOSC), says: "China's banking industry keeps serving the real economy, regarding this as the main line of work. This is in consistent with the direction of policies and the focus of banking transformation and upgrading. Those industries suffering from the epidemic only accounts for little proportion of the banking business, and efforts are made to help them survive and revive. Under the condition that the long-term positive trend of China's economy remains unchanged, the overall impact on the banking industry will be limited. The total assets of China's banking industry achieved the growth of 11.0% and 8.6% respectively in 2020 and 2021, and non-performing loan ratio declined by 0.02% and 0.11%."
Providing assistance for the country's small and medium-sized enterprises (SMEs) is also high on the list of priorities for China's banks. The PBOC urged banks to increase their support for SMEs during May 2022, calling for banks to "go all out to stabilise the fundamentals of the economy".
With the CBIRC, the PBOC told banks to lend more to small firms and companies involved in specific sectors, including energy supply and green technology development. The CBIRC has stated banks NPL ratios are currently at an acceptable level.
The banks are aware of the problem being faced by their small business customers. "The banks should follow the trend of industry and finance integration, efficiently serve enterprises along the industrial chain, both upstream and downstream as well," says Mr Jin.
"In recent years, Bank of Shanghai has actively developed online supply chain financial services, with the scale of related business increasing by nearly 115% in 2021 from the previous year," he says.
"Second, the Bank should solve information asymmetry through co-operation with governments, chambers of commerce and industrial parks to ensure that financial services can reach SMEs accurately and efficiently. For example, Bank of Shanghai and the Shanghai Guarantee Fund jointly launched four-part serves by the governments, the guarantee funds, the industry parks and commercial banks, with the number of customer enjoyed the services jumping 46% from previous year."
Third, banks should be in line with the direction of economic transformation and upgrading, closely follow industrial development, keep industry research, and refine service models, says Mr Jin. "The banks should also focus on the whole life cycle of enterprises, recognise customer needs, and provide comprehensive financial services not limited to lending only," Mr Jin adds.
A spokesperson for Ping An Bank says: "We assist micro-enterprises and SMEs (MSMEs), and other market players, by reducing their burden and continuously improving the service of inclusive finance. As of the end of March 2022, Ping An Bank had a total of 917,900 small and micro-enterprise clients benefiting from inclusive finance. The balance of inclusive finance loans was Rmb405.07bn, up by 6% from the end of 2021."
The digital banks also responded to the call to provide additional support. At the end of 2021, WeBank extended its Weiyedai services to key industries to provide credit for 140,000 MSMEs with upstream and downstream links within industrial supply chains. Nanqing Li, president of WeBank, says: "As of the end of 2021, WeBank's total assets reached Rmb438.7bn. Among them, total loan balances reached Rmb263.2bn, a year-on-year growth of 32%, and the balance of inclusive loans for MSMEs grew 40% year-on-year."
With Weiyedai, its contactless unsecured online working capital loan product, WeBank allows companies to defer payments on loans by three months, effectively lowering interest rates and account management fees.
"The latest data shows that Weiyedai has cumulatively reached over 2.7 million MSMEs and has cumulatively granted a line of credit to more than 880,000 customers," Mr Li adds. "Eighty percent of these customers have an annual revenue of less than Rmb10m, and about 60% of them obtained a bank loan for the first time. In 2021, the number of first-time Weiyedai borrowers increased by more than 90,000."
While this is helping to support vulnerable companies, Moody's Mr Zhu is unconvinced that additional lending will benefit the banks. "There is a general moratorium on loans that have been affected by the lockdown. It is wide-ranging, covering individual consumers, business owners and SMEs. If the business is affected, the banks are obliged to consider extending loans. We think this is credit negative for banks, as the moratorium means delayed cashflow back, but should help the borrowers," he says.
However, the policy itself is not new, as it has been extended since the outbreak of the pandemic in 2020. "There is a question as to why more SMEs would not take up this offer," says Mr Zhu. "The reason is largely because the borrowers prefer the refinancing opportunity to the extension of the loan payment. For businesses that are looking to open up again after lockdown, it is more important for them to get additional financing for raw materials to use, or to invest into expanding facilities, for example. Secondly, if a company has no expectation of coming back, it would ask for a cancellation of the debt rather than asking for the loan to be prolonged."
While the banks grapple with the issues of the real economy, progress continues within China's digital banking space. After initially leading the way globally in its development, the progress being made in the central bank digital currency (CBDC) may not be at the pace originally hoped.
Banks included in the process range from the state-owned enterprises, including ICBC, Agricultural Bank of China, Bank of China and China Construction Bank, along with commercial banks including Postal Savings Bank of China and China Merchants Bank. The Ant Group-owned digital only MYBank is also part of the pilot cohort.
Not all participants are able to comment on how the process is developing from their perspective; one commenter could not provide updates due to confidentiality restrictions.
S&P's Mr Hu says that at the end of 2021, the CBDC – also known as the e-CNY – was in 261 million wallets, with transactions totalling Rmb87.6bn. "It is not a significant amount so far, but it is growing," says Mr Hu. "During the first week of the Winter Olympics, Rmb9.6bn was transacted using e-CNY."
While the numbers look impressive, they are dwarfed by other statistics. For example, during the Singles' Day shopping event, Alibaba reported Rmb540.3bn in sales over an 11-day period.
How fast these numbers can grow remains to be seen, as the coming phases of implementation may be at a more measured pace than is normally seen for fintech adoption in China, as it is coming from the central bank rather than led by private enterprise.
Mr Zhu says: "Our prediction is that the next phase of the CBDC rollout will be much slower. There will likely be more trial cities in the next two to three years. We do not believe the CBDC will disrupt banks and their payments business at the initial stage of e-CNY.
"There is some thought that e-CNY might disrupt the incumbent banks, and while e-CNY may take some of the market share, the PBOC won't want that to happen," he adds. "The slower pace of implementation will also give banks longer to adjust to the incoming changes through updating systems and internal processes."
The technical aspects of developing the currency may be more complex than originally anticipated. Mr Chan says: "The central bank was initially very ambitious about the CBDC, but they have changed their plans due to a number of issues. There was a question on how to use encryption technology for blockchains. The central bank was very confident in this, but the reality has not been smooth to implement. Now they have decided not to use blockchain for the digital currency. We worry about how this will impact the legal status of the currency."
However, without outside knowledge of how exactly the system works, predicting its capabilities is almost impossible. "Trusted state-owned banks are linked directly to the PBOC's e-CNY system, which makes transactions a lot faster," says Mr Hu. "What is not known is the exact technology supporting the distributed ledger technology, but we understand it can handle a lot of transactions."
Regardless of the technology, Mr Hu believes that banks will be an integral part of the process. "We believe the central bank will continue to use intermediaries for conducting transactions on the e-CNY, which means they need banks," he adds. "It's hard to imagine the central bank alone will achieve the same level of customer service if they remove the banks altogether and deal with the end-user directly. The banks will also manage the know your customer and anti-money laundering aspects."
The banks are pushing ahead with their own digital agenda. In November 2021, Ping An Bank successfully connected to the trade finance blockchain platform of the Digital Currency Research Institute of the PBOC and completed the first cross-border trade finance transaction on the platform.
"Ping An Bank insists on innovation, strengthens the application of leading technologies, deepens the innovative application of Internet of Things, blockchain, artificial intelligence, big data and other technologies in the financial field, and promotes the digitisation and intelligent upgrading of operation and management," the Ping An spokesperson says.
Media Link: https://www.thebanker.com/Top-1000-World-Banks/China-s-banking-sector-feels-the-strain?ct=true
