Bad debt below 1 percent in China soon?

September 9, 2009

After the credit emission in China during the first half, international investors are concerned that bad debt will pile up after three years. Bankers in China are certainly a lot more optimistic.

More than 50 percent of the bankers surveyed by PricewaterhouseCoopers and China Banking Association expect the ratio of banks’ non-performing-loans to range between 1 percent and 5 percent of the total over the next three years. Indeed, 30 percent expect the ratio to be below 1 percent.

True, NPLs are currently at a record low of 1.8 percent . But given the recent lending frenzy, it is surprising that such a high number of bankers would expect it to drop further rather than inching up. Perhaps they are betting on another clean-up of bad debt so the ratio will get reset to zero?

There are also some seemingly self-contradictory answers that belie their concern of the property market. As much as 63 percent of respondents say they will continue to support mortgage and personal loans but most of them (79 percent), want to be prudent on lending related to property developers, a group that has been kicked around by some heavy handed policies.

Chinese banks still have the sword of Damocles hanging above them – interest rate deregulation may lead to cut-throat competition, as seen in the events leading up the U.S. savings and loans crisis. In the survey bankers unanimously agree that Beijing should not let that sword fall anytime soon, arguing that interest rate deregulation will lead to market segmentation, with small- and medium-sized banks hurt most.

Given that Chinese banks have never gone through a prolonged downturn after the cleanup of their bad debt and remain largely untested, it does sound like a good idea to protect their margins a bit longer until they have developed a more diversified revenue base which includes more income from credit cards and wealth management.

But who is to blame for Chinese banks’ vulnerability? Since Beijing does not allow commercial banks to offer brokerage business, they have to rely heavily on bank credit to boost profits. If the economic cycle turns in three years, NPL ratios are likely to soar, not fall.

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