Take Chinese bank earnings with a pinch of salt

August 26, 2011

By John Foley
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

HONG KONG — China’s five biggest banks grew combined earnings by 37 percent during the first half of 2011. Lending margins and fees rose, while bad debts fell. In a sign of high times, some big banks are now even offering their best customers private jet services. Yet there is still plenty to worry about, and that explains why their shares have fallen roughly a quarter from this year’s peak.

There are three concerns. The first is that after two years of rapid lending, bad debts are a problem. There are already early signs a slowing economy is taking its toll. Despite falling bad debts overall, loans overdue by less than three months spiked 36 percent at Bank of China. At ICBC, loans three to six months overdue grew by 35 percent. At Minsheng they more than doubled.

The second concern lurks off the balance sheet. Banks have stuffed loans and securities into wealth management products that are sold to clients desperate to beat the 3.5 percent one-year deposit rate. If the underlying assets go bad and the products can’t be repaid, the banks are usually not technically liable, but the risk is that they will be forced to take the losses nonetheless.

Agricultural Bank of China, Bank of Communications, CCB and Minsheng sold an astonishing 7 trillion yuan of wealth management products in the first half. AgBank revealed, in a footnote, that products guaranteeing investors their money back are 4 percent in the red. Meanwhile, the off balance-sheet commitments disclosed, like undrawn loans and letters of credit, shot up. Minsheng’s grew 42 percent over the period, ICBC and AgBank half as much.

For all that, the big banks are liquid and soundly capitalised. But smaller banks are a different story. The minnows can’t win customers on price because their deposit rates are fixed. This has pushed up rates in the interbank market as they clamour for funding from their rivals. AgBank is one that took advantage, doubling its “placements to other banks” during the period. Yet if small banks really get into trouble, some big state-owned banks may be forced to take them over rather than profit from their difficulties.

Bad debts, risks lurking off the balance sheet, and a wave of potential takeovers of weak banks all sound distant. But it isn’t hard to see why investors aren’t taking China’s super-strong financials at face value.

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