New LDR Rules Could Raise Chinese Banks Asset Quality Risk

The recent decision by the China Banking Regulatory Commission (CBRC) to amend the calculation of Chinese banks’ loan-to-deposit ratios (LDRs) is part of an ongoing targeted easing of liquidity conditions. But spurring growth of lending to small- and micro-enterprises (MSEs) has the potential to hurt bank credit profiles over the medium term, says Fitch Ratings in a report.

The new calculation excludes foreign-currency loans and deposits while also relaxing some of the qualifications for both the numerator and denominator of the ratio. Six types of loans targeting the agricultural and the MSE sector will be removed from the numerator, and negotiable certificates of deposits (NCDs) and deposits from an overseas parent bank will be allowed as part of the denominator.

The action may result in lower reported LDRs for some banks, but will not alter liquidity positions in the near term, nor is it certain that it will give a meaningful boost to growth in loans to borrowers most in need.

The LDR change targets MSEs and the agricultural sector while continuing to restrict the growth of total credit, as with an earlier selective reduction in reserve requirement ratios. The policy decision reflects the ongoing challenge of regulators as they seek to re-balance the economy away from capital investment and reduce the role of the shadow banking sector while avoiding a sharp economic slowdown.

MSEs tend to be more vulnerable during economic downturns, and more sensitive to economic cycles. So this could have a negative impact on the credit profile of the banking sector over the medium term, by further enabling increased credit for a sector which is generally associated with higher credit risk.

There are also risks should loans to MSEs be re-routed into property or other speculative investments such as shadow banking products, which would undermine the government’s objectives to reduce funding to these areas.

People’s Bank of China data confirms that MSE lending is one of the higher growth areas for Chinese banks. MSE credit grew by 13.7% in 2013, which was several percentage points higher than that for large and medium corporations – 10.4% and 9.8% loan growth was recorded for large and medium enterprises, respectively.

New loans for MSEs totaled RMB2 trillion and accounted for 44% of total new corporate loans in 2013, up from RMB1.7 trillion and 36% in 2012.

From a liabilities perspective, the new LDR calculation has the potential to alter Chinese bank’s funding structures. The broadening of the definition of deposits means that banks could increase their use of NCDs and bonds to fund lending to certain sectors relative to deposits.

Caishen.Co - Primary Data for China Secondary Investment and Stock Markets
Caishen.Co - Primary Data for China Secondary Investment and Stock Markets