China's moves to tighten monetary policy and contain credit risks could significantly weaken bank profitability in the next few years, and may lead to a sharp rise in bad assets, Standard & Poor's said Wednesday.
The ratings agency reaffirmed its stable outlook for China's banking sector, but said big banks are likely to adapt better to policy tightening due to their stronger capital base.
"Inflation and a possible economic slowdown stemming from tightening measures could lead to a spike in credit losses over the next two to three years," said Qiang Liao, director of financial services ratings at Standard & Poor's.
"Chinese banks' profitability could slip in the remainder of 2011 and drop further in the next two years, despite the strong rebound in 2010 and no signs of slippage in the first quarter of this year," he said.
Curbing inflation is a top priority for China's authorities, prompting them to take a series of measures, including successive interest rate hikes and increases in the share of deposits banks must keep on reserve.
Banks' first-quarter earnings suggested Beijing's moves to cool the economy are having an impact. Profits continued to grow strongly, but at a slower pace than last year. Industrial & Commercial Bank of China Ltd., China's largest bank by assets, posted a 29% rise in net profit compared with a year earlier, below the 32% rise in the fourth quarter, while Bank of China Ltd.'s net profit growth slowed to 28% from 34% over the same period.
"Considering the cumulative effect of China's ongoing tightening measures, particularly reduced new credit availability and higher rates, we expect the sector's cumulative nonperforming loan ratio to reach 5%-10% of total loans in the next three years," said Liao.
The estimate, which marks a sharp increase from an average 1.14% NPL ratio at the end of 2010, is based on a scenario in which lending rates rise significantly and government support for project loans turns out to be negligible, according to Standard & Poor's.
Banks in China issued roughly CNY18 trillion (US$2.8 billion) worth of loans in the past two years to support the government's economic stimulus efforts. The eye-popping lending tally has been blamed as a significant source of inflation and raised widespread concerns about the long-term health of the banking sector.
Memories of a massive government bailout of state-owned banks beginning in 2000 have prompted Beijing to take steps to curb rising credit risk in investment-intensive sectors, especially real estate and local government infrastructure development.
These measures include higher requirements for banks' capital adequacy, higher mortgage rates and down-payment requirements, more frequent stress tests on the impact of a decline in property prices, and a crackdown on gray-market financing from trust companies.
Liao said these measures could lead to a greater divergence in credit quality between major players and small lenders. "The pain will be uneven across the sector. The major banks, especially the top-tier banks that we rate, should be able to manage the effects of policy tightening because of their stronger loss buffers and credit risk controls," said Liao.
"But smaller institutions could struggle due to their asset concentration and less-favorable liquidity profiles," he said. Analysts said the increases to banks' reserve requirement ratio have put pressure on small and medium-sized banks to meet the 75% loan-to-deposit ratio ceiling. In China, most banks use customer deposits to fund their operations.
Small and medium-sized banks have started refinancing programs in recent months to shore up their capital base. China Citic Bank Corp. said it expected to complete a CNY26 billion rights issue in Shanghai and Hong Kong by the end of June. China Minsheng Banking Corp. plans to raise as much as CNY21.5 billion from the sale of new Shanghai-listed shares in a private placement. Regional lender Bank of Beijing Co. intends to raise CNY21.8 billion via a private placement and a bond sale on the domestic market.
But in the face of a weak stock market, Chinese banks have become more reliant on bond issues to raise funds, and this has meant higher funding costs as a result of climbing interest rates.
China International Capital Corp. said in a note that it expects the net increase in subordinated bonds issued by banks to reach CNY130 billion to CNY150 billion this year, three times the amount of last year.