Why Chinese banks are still in strong shape

Published 2nd September 2015, 19:00 HKT

Recent media reports quite rightly cite sluggish profit growth, rising non-performing loans and increasing risk exposure to the stockmarket as the basis for a negative outlook on Chinese banks. The following is a bullish response from a Chinese economist which cites wider issues that can support China’s banks.

Source: Translated from an article published in the 21st Century Business Herald this morning, and written by Zhong Wei, professor and director at Beijing Normal University’s Finance Research Center, and also a researcher at the Chinese Academy of Social Sciences.

  • China’s interest rate liberalisation is now in its final stage. Although this will reduce the official interest rate spread, and therefore hit bank profits, it will also arrest shadow banking expansion. At the same time, financial and technological disintermediation is increasing, which means more direct channels for bank credit. It now seems the worst is over, and falling risk-free interest rates will be of benefit to bank profits.
  • The implementation of the deposit insurance scheme and the steps towards replacing business tax with value added tax (VAT) sees the threat of external policy shocks disappearing. Although the new deposit insurance scheme will not reduce the likelihood of banks going bankrupt, it will make bankruptcy proceedings more orderly. The cost of the deposit insurance scheme could shave one percent off banking industry growth. System overhaul for the major banks under the new tax system could cost five to ten billion yuan, and the costs of VAT are estimated at tens of billion yuan per year. The negative impact on bank profits is undeniable.
  • Everyone is concerned with the deteriorating quality of bank assets. Yet a series of measures are transferring those risks away and increasing liquidity. Firstly bringing shadow banking back onto the balance sheets and stabilisation in the property market. Secondly, the Ministry of Finance led local government debt swap program. Thirdly bank asset securitisation.
  • Bank dividends are still attractive. In the first half of 2014, banks paid dividends between six and nine percent. And looking at share prices verses other A-shares, valuations appear reasonable.
  • In 2003, China’s banking system experienced a complete overhaul, which resulted in rapid improvements in its IT infrastructure. The three main areas of improvement were distributed networks, big data, and the consolidation of back office operations. In the Chinese banking industry, the percentage of non-counter personal customer transactions as a total of all transactions in Chinese banks is usually above 85%, and almost all interbank or business banking transactions are conducted online. People will slowly realise that traditional banks are well placed to benefit from the latest ‘internet plus’ policy.
  • Chinese banks international competitiveness is by no means weak, especially considering its efficiency, finance IT, and high profit margins. Following entry into the WTO, the mediocre performance of foreign banks in China proves this. The potential for Chinese banks to make inroads into global markets is huge.
  • Interest rate liberalisation in the West triggered two trends of restructuring through mergers and acquisitions and business line diversification. We can see in China that banks will be the leading players in a wave of finance sector restructuring, and rather than becoming weaker, will to some extent be stronger.
  • Bank shares were not popular during the bull run in the first half of the year, and during the stockmarket turmoil in July and August, after initial support, bank stocks fell out of favour with the government’s ‘plunge protection team’. The banks faced a series of problems such as insufficient credit demand and challenging growth prospects, but the shares still held up. Following the stockmarket scares, investors are now willing to look at the fundamentals, which is why apart from bonds, money is now pouring into stable bank stocks.

Some of the points appear to contradict Western held views, for instance realistically how can Chinese banks be more competitive than international banks? But other points are worth bearing in mind, for instance the potential for restructuring in the industry, and growth in overseas markets.

One aspect the author fails to mention is the controlling hand of the state, which directs the banks to ‘act’ like banks, whilst holding the safety net in case they fall. The Chinese government spent a lot of money clearing bad debts from banks during the late 1990s, hence it would be naive to assume the state would not step in again in the event of a financial crisis.

(Article not to be copied without permission)

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