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 communication@bruegel.org.

View comments
Read article More on this topic

Opinion

Sticks and carrots from China’s leadership to Chinese banks

The takeaway from the 13th National People's Congress (NPC) is clear: under the current economic downturn, Chinese authorities will do whatever it takes to support the real economy. Alicia García Herrero and Gary Ng reflect on the "sticks snd carrots" approach to Chinese banks.

By: Alicia García-Herrero and Gary Ng Topic: Global Economics & Governance Date: March 21, 2019
Read about event More on this topic

Past Event

Past Event

The trade crisis: good and bad scenarios and the EU's response

What role will the EU play in the resolution of the global trade crisis?

Speakers: Uri Dadush, Maria Demertzis and Denis Redonnet Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: March 20, 2019
Read article More on this topic More by this author

Opinion

China’s debt is still piling up – and the pile-up is getting faster

With looser monetary policy, China's policymakers hope to encourage banks to lend more to the private sector. This seems to imply a change from the deleveraging drive begun in mid-2017. Although this should be good news for China's growth in the short term, such a continued accumulation of debt cannot but imply deflationary pressures and a lower potential growth further down the road.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: March 19, 2019
Read article More by this author

Opinion

New EU industrial policy can only succeed with focus on completion of single market and public procurement

France and Germany recently unveiled a manifesto for a European industrial policy fit for the 21st century, sparking a lively debate across the continent. The fundamental idea underpinning the manifesto is a good one: Europe does need an industrial policy to ensure that EU companies remain highly competitive globally, notwithstanding strong competition from China and other big players. However, the Franco-German priorities are unsuitable for the pursuit of this goal.

By: Simone Tagliapietra Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: March 18, 2019
Read article More on this topic More by this author

Blog Post

Russia's foreign policy does not help its economic modernisation

In the highly interdependent modern world, a country’s economy and its foreign policy are strongly linked. A country’s foreign-policy ambitions should correspond to its economic potential, but Russia’s over-ambitious foreign ventures have exacerbated the negative effects of the numerous economic headwinds it faces.

By: Marek Dabrowski Topic: Global Economics & Governance Date: March 6, 2019
Read article More on this topic More by this author

Opinion

Tense transatlantic relations put EU in tough spot

The global multilateral system is being challenged by the US and China, which prompts the EU to rethink how well it can compete in the world.

By: Maria Demertzis Topic: Global Economics & Governance Date: March 5, 2019
Read article More on this topic More by this author

Blog Post

The possible Chinese-US trade deal

The future of Sino-American relations after the incoming end of trade talks between Beijing and Washington. We review opinions in the English-speaking blogosphere on the likely content of the deal and the message this agreement sends to the world.

By: Jan Mazza Topic: Global Economics & Governance Date: March 4, 2019
Read article More on this topic More by this author

Opinion

China's strategy: Growth, alliances, and tech acquisition

Despite the pause in the US-China trade war, the US and China are strategic competitors, and will continue to be so for the foreseeable future. China realizes that there is little room to settle long-term disputes and, as a result has shifted towards a strategy that focuses on sustaining growth at any cost, expanding alliances, and advancing its technology.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: February 27, 2019
Read article More on this topic More by this author

Blog Post

Greening monetary policy: An alternative to the ECB’s market-neutral approach

The ECB’s market-neutral approach to monetary policy undermines the general aim of the EU to achieve a low-carbon economy. An alternative tilting approach would foster low-carbon production, accelerating the transition of the EU to a low-carbon economy, and could be implemented without undue interference with the chief aim of price stability.

By: Dirk Schoenmaker Topic: European Macroeconomics & Governance Date: February 21, 2019
Read article More on this topic More by this author

Podcast

Podcast

Deep Focus: A greener monetary policy approach for the ECB

Bruegel fellow Dirk Schoenmaker walks Sean Gibson and 'The Sound of Economics' listeners through his latest working paper, focusing on how to make monetary policy in Europe more climate-friendly

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: February 21, 2019
Read article Download PDF More by this author

Working Paper

Greening monetary policy

The author proposes a tilting approach to steer the allocation of the Eurosystem’s assets and collateral towards low-carbon sectors, which would reduce the cost of capital for these sectors relative to high-carbon sectors. Central banks have already started to look at climate-related risks in the context of financial stability. Should they also take the carbon intensity of assets into account in the context of monetary policy?

By: Dirk Schoenmaker Topic: Energy & Climate, European Macroeconomics & Governance Date: February 19, 2019
Read article

Opinion

What can the EU do to keep its firms globally relevant?

There is a fear that EU companies will find it increasingly difficult to be on top of global value chains. Many argue that EU-based firms simply lack the critical scale to compete and, in order to address this problem, that Europe’s merger control should become less strict. But the real question is where the EU can strengthen itself beyond the realm of competition policy.

By: Georgios Petropoulos and Guntram B. Wolff Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: February 15, 2019
Load more posts