China Debt Under Control?

In September last year, the Bank for International Settlements issued a damning assessment of Chinese Debt and its  banking sector, in particular: it would face a crisis in three years if it didn’t get the house in order. 

The report focused on the credit-to-GDP gap, which hit 30.1 in China in the first quarter of this year. Based on historical trends, countries with a credit-to-GDP gap of more than ten have been subject to a crisis in “any of the three years ahead.” At the time of the report, China’s indicator is way above the second highest level of 12.1 for Canada and the highest of the countries assessed by the BIS.

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It seems that the country’s policymakers took this warning seriously as, over the past year, regulators and lawmakers have been working to try to control Chinese debt and financial system excess. To some extent, these efforts have yielded results.

Total loans coming down

According to a report published by credit rating agency Moody’s last week, “regulatory measures implemented since January have been successful in containing financial risks and unwinding some shadow banking and interbank activities” at the 16 publically traded banks the group follows. These banks account for more than 70% of the total assets in Chinese commercial banks.

That being said, even though the report notes progress is being made, it is slow. Average asset growth slowed markedly to 4.4% in the first half, led by declines in investment in loans and receivables. Asset quality improved as loans declined for the 16 banks by an average of 27 basis points to 3.02% of total loans. New delinquencies fell to an average of 0.73% of total loans in the same period, compared with 1.27% a year earlier. All banks considered reported loan loss reserves exceeding their 90+ day delinquencies and an average core tier 1 capital ratio of 10.85% at the end of the first half, down nine basis points year-on-year. Average loan/deposit ratios were 83.5%.

However, despite the improving credit profile, profitability slowed. The average net interest margin reported declined 17 basis points to 2.03% annualized in the first half.

Moody’s peer S&P Ratings also believes that China is heading in the right direction. Bloomberg notes that in a recent report analysts at the agency noted the country is taking “baby steps” toward cutting leverage. The next big step for the region will be whether companies can withstand higher funding costs, particularly, “Smaller and less-capitalized banks,” which “may feel the liquidity squeeze and pressures on their capital, leading to distress; and default risks could also increase for the local government financing vehicles,” Source –

Chinese debt collapse ahead? Watch out as the risks have not gone away warns one big bank.

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