Opinion

Chinese banks’ improved asset quality cannot hide other phantoms

The recent improvement in asset quality cannot mask other growing concerns in China’s banking sector. Beyond liquidity concerns, other structural issues such as low profitability and insufficient generation of organic capital, are emerging.

By: , and Date: December 20, 2017 Topic: Finance & Financial Regulation

This opinion piece was published in:

Robust economic growth and, especially, higher industrial prices have pushed up Chinese corporates’ profits since 2016. This comes as an upturn after a horrible 2015. Indirectly, this has also helped banks as it has increased companies’ cash flows to repay their large debt burden. However, this improvement in asset quality cannot mask other growing concerns in China’s banking sector. Beyond liquidity concerns, which are real but still can be managed by the PBoC’s lax monetary policy stance, there are other structural issues emerging, namely low profitability and insufficient generation of organic capital. This is not because Chinese banks are not profitable but the amount to revenue generated to keep up with the rapid speed in balance sheets. In other words, Chinese banks’ balance sheets – although decelerating – are still growing too fast. Below is a more detail account of Chinese banks’ structural problems.

While the worst seems to be over in terms of profitability – as net profit growth has rebounded from a low point in 2015 – the gap between asset and profit growth is still large, pushing down banks’ return on assets (ROA) and return on equity (ROE). The insufficient profit growth stems from an increasingly meager interest income, which is still the bulk of Chinese banks’ income. This situation is particularly difficult for smaller banks. The latter have long need to fight hard for liquidity and this has pushed up their funding costs and, thus, reduced their net interest rate margin. The other factor is policy. The large scale local government debt swaps have increased banks’ investment book but have also lowered the average  interest rate that banks are getting for their loans to local governments (from an average of 10% to now 4%). In other words, their lending since 2008 has ended up being safer condition but certainly less profitable.

Finally, the helping hand that Chinese banks were expecting to receive from non-interest income is increasingly limited due to the crackdown on off-balance sheet items and shadow banking. As a response, banks have switched to expanding income sources from credit cards and advisory business, but it has proven hard to substitute the previous sources of non-interest income. As if this were not enough, Chinese banks’ cost of funding continues to increase. The lower profitability is reducing the ability of Chinese banks to generate organic capital and fueled the urgent need to seek capital elsewhere. Such demand will only increase down the road as the CBRC imposes TLAC requirements down the road.

All in all, the improvement in asset quality by sharing the risks with rest of the financial sector could be a relief for banks but it actually not enough to keep pace with the growth of assets of Chinese banks. Down the road, more stable sources of income and more organic generation of capital will be needed for Chinese banks’ to be totally out of the woods after a massive credit binge.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to [email protected].

Read article More on this topic More by this author
 

Opinion

An EU - China investment deal: a second look

For the moment, it does not look like we have the basis for greater and deeper economic relations with China. However, dismissing China and the opportunities that it creates for global cooperation would also be a mistake.

By: Maria Demertzis Topic: Global Economics & Governance Date: January 19, 2021
Read about event More on this topic
 

Upcoming Event

Jan
20
15:00

Monetary and fiscal policy interaction in times of Next Generation EU

Could Next Generation EU enable a better coordination of monetary and fiscal policy

Speakers: Lorenzo Bini Smaghi, Grégory Claeys and Hans Vijlbrief Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic
 

Upcoming Event

Jan
27
16:00

In search of a fitting monetary policy: the ECB's strategy review

The ECB is reviewing its monetary policy strategy. How to ensure monetary policy is fit for purpose in a fast changing world?

Speakers: Maria Demertzis, Philip Lane, Reza Moghadam and Erik F. Nielsen Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author
 

Opinion

Europe's disappointing investment deal with China

Why rush a deal that is so inherently complex?

By: Alicia García-Herrero Topic: Global Economics & Governance Date: January 4, 2021
Read article Download PDF
 

Parliamentary Testimony

European Parliament

Monetary Policy in the times of corona: many unknown unknowns

Testimony to the European Parliament on monetary policy.

By: Maria Demertzis and Marta Domínguez-Jiménez Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: December 21, 2020
Read article More on this topic More by this author
 

Blog Post

When and how should the European Union conclude an investment agreement with China?

A look into the potential Comprehensive Agreement on Investment between China and the European Union.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: December 17, 2020
Read article More on this topic More by this author
 

Opinion

A silver lining for ageing Asia

An ageing population is generally bad news for growth prospects, but Japan and Taiwan offer important lessons.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: December 8, 2020
Read article More on this topic More by this author
 

Opinion

Grading the big pandemic test

COVID-19 almost one year on, it is time to assess who passed the test, and who failed.

By: Jean Pisani-Ferry Topic: Global Economics & Governance Date: November 27, 2020
Read article More on this topic
 

Blog Post

Europe is losing competitiveness in global value chains while China surges

The European Union owes much of its economic weight to its regional value chain and integration into the global value chain. But the EU’s global value chain role is shrinking, and while EU trade integration with China is increasing, it is mainly to China’s benefit, undermining the EU’s external competitiveness.

By: Alicia García-Herrero and David Martínez Turégano Topic: Global Economics & Governance Date: November 27, 2020
Read article More by this author
 

Podcast

Podcast

Steering the boat towards an unknown destination

Shocks pass, but change remains a constant. We need to start focusing on permanent changes in the economy and how to adapt to them.

By: The Sound of Economics Topic: European Macroeconomics & Governance, Global Economics & Governance Date: November 25, 2020
Read about event More on this topic
 

Past Event

Past Event

How to keep a competitive environment while engaging with non market economies?

How can we ensure fair competition between European firms and Chinese state-backed players?

Speakers: Julia Anderson, Helge Berger, Michiel Boots, Alicia García-Herrero, Carles Esteva Mosso, Frédéric Jenny, Georgios Petropoulos, Cian Ruane, Hylke Vandenbussche and Guntram B. Wolff Topic: Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: November 19, 2020
Read article More by this author
 

Podcast

Podcast

Sizing up the world's largest trade deal

What should be Europe's strategy towards the Regional Comprehensive Economic Partnership (RCEP)?

By: The Sound of Economics Topic: Global Economics & Governance Date: November 18, 2020
Load more posts