Chinese banks’ loan quality will deteriorate noticeably in 2014 as problems start to emerge in China’s local government debt sector, Standard & Poor’s Financial Services writes in a newly released report.
Chinese banks’ reported ratio of nonperforming loans (NPLs) to total loans of commercial banks stand at about 1% at the end of 2013.
But S&P says the low official NPL ratio is mainly because of solid expansion in real GDP and unabated strong credit growth.
Total loans grew 13.9% to RMB76.6 trillion in 2013, compared with a growth rate of 15.6% in 2012. However, expansion in shadow banking, meaning those involving entities and activities outside the regular banking system, more than compensated for the slowdown in loan growth.
S&P estimates that total credit in the economy, including both regular and shadow banking credit, grew by 18% to 19% in 2013.
Loans extended to manufacturers saddled with overcapacity, such as steel and cement producers, will also become troubled as China’s decade-long construction boom is cooling.
The Chinese government appears to be determined to tackle the overcapacity issue. Many companies in the targeted industries have therefore suffered from reduced access to bank credit in recent years.
S&P believes government-engineered consolidation in these segments will reduce production capacity and could lead to a rise in NPLs for Chinese banks over the next two years.
In addition, the corporate sector remains under pressure from China’s slowing economy. The upward trend in the proportion of loss-making industrial companies persists, hitting 13.7% at the end of November 2013.
That’s barely improved from a year earlier and up significantly from the decade low of 9.4% at the end of 2011.
In addition, tightened market liquidity may exacerbate short-term pains for corporate bond issuers. Escalated funding costs in the bond market since June 2013 will weaken companies’ debt servicing capacity.
Nonetheless, loans remain the mainstay of corporate financing, while any spillover effect from rising bond yields on loan pricing has been limited.
Authorities’ efforts to rein in the rapid growth in shadow banking could have unintended consequences for other parts of the banking system. Shadow banking has played a growing role in China’s credit supply, particularly for financing local government projects, property development, and other risky segments.
The government has been trying to contain credit supply to these unproductive segments. A drain of credit for these segments may lead to a spike in NPLs.