But many believe that the underlying faultlines remain
GUO SHUQING, China s new banking regulator, knows the enormity of his task.
China s banking system, he observed last month, is worth more than $33trn. So
it is bigger than any other country s, and even than Europe s as a whole. And
he is well aware of the pitfalls left by a decade of breakneck lending growth.
But if Mr Guo is nervous, he is hiding it. All problems and contradictions
will be resolved, he says.
Of course, a Chinese official can be expected to express confidence about
Chinese banks. More surprising is that a small but growing number of analysts
and investors seem to concur. Chinese bank shares are up by a quarter since
early last year. One investment bank, Morgan Stanley, has declared that China s
lenders are in a sweet spot . Another, Goldman Sachs, has upgraded China to
overweight that is, recommending that clients buy Chinese shares and is
especially positive about the banks. Shanghai Financial News, a local
newspaper, described the new mood around these giant institutions as the
return of the king . The question is whether it will be a long, stable reign or
a short-lived, turbulent one.
The clearest positive for China s banks has been an upturn in nominal economic
growth. Real GDP growth (ie, accounting for inflation) is likely to be little
changed in 2017 from last year s 6.7%. But nominal growth is nearly 10% in yuan
terms, up markedly over the past 12 months. Higher prices have led to stronger
corporate revenues, particularly for indebted steel-producers and coalminers.
This, in turn, has made it easier for them to repay loans. Chinese banks
official bad-debt ratio, climbing since 2012, held steady last year at about
1.7%. Many analysts still think the real level of toxic loans is many times
that (some estimate the ratio is as high as 19%), but the bleeding has clearly
slowed.
Meanwhile, banks have started to clean up their balance-sheets. In part, this
has been through more write-offs of problem loans. Banks took losses on more
than 500bn yuan ($75bn) of loans last year, a record, scrubbing them from their
books and selling some to investors. With more credit going to infrastructure
projects and to mortgages, which traditionally have been safe in China, loan
portfolios are looking healthier. Richard Xu of Morgan Stanley reckons that
high-risk credit will decline from about 6% of total credit in China today to
less than 3% by 2020.
There are also signs that China s bloated state-owned banks are getting a
little more efficient as they respond to competition from fintech companies.
The four biggest banks, which account for nearly two-fifths of the industry s
assets, cut employees in 2016 for the first time in six years. Banks have been
rolling out mobile apps to handle payment and investment transactions that used
to be conducted in person. Overall costs of listed banks rose by just 0.6% last
year, even as assets grew by 12%.
All these good omens, however, may not mean China s banks have really turned
the corner. The beautification of their books has relied on financial
engineering. Over the past three years the government has approved the creation
of 35 asset-management companies (ie, bad banks ). Jason Bedford of UBS, a
Swiss bank, says that these companies, which buy delinquent loans from banks,
often also finance themselves through bank loans.
Debt-for-equity swaps are another form of financial engineering: instead of
repaying loans, indebted companies can issue shares to third parties, which
acquire the loans from banks. Yet the fine print shows that their equity
functions like bonds: the companies must pay dividends and buy back shares if
they miss revenue targets. Moreover, the parties holding the equity are funded
in part by investment products sold off-balance-sheet by banks. The upshot is
that, whether stashed in bad banks or converted into equity, the debt could yet
bounce back into banks hands.
The simple problem that underlies this complex restructuring activity is
excessive lending growth. China s total debt-to-GDP ratio has risen from less
than 150% before 2008 to more than 260% today; in other economies, such
increases have often presaged severe financial stress. Aware of the dangers,
the Chinese government has made reducing debt a priority. It is taking baby
steps towards that goal: thanks to faster nominal growth, China s debt-to-GDP
ratio will expand more slowly this year. But it will still expand. S&P Global,
a rating agency, warned in March that this trajectory for Chinese banks is
unsustainable.
Efforts to curb borrowing are themselves emerging as a new risk. Over the past
few months the central bank has raised banks short-term borrowing costs. That
has been a shot across the bows of overextended lenders, especially mid-tier
banks. These have been most aggressive in funding themselves with loans from
other banks, rather than doing the painstaking work of building up bigger
deposit bases.
Already this tightening has led to volatility. In March the central bank made
an emergency liquidity injection after small banks were reported to have missed
interbank debt payments, suggesting that the basic gears of the financial
system were starting to get gummed up.
For many in the market, the cons in Chinese banking outweigh the pros. Bank
shares have rallied since last year, but investors still price them just at
about 80% of the reported value of their assets (see chart). In other words,
they expect more bad news to come if not this year, then soon enough. From his
seat in the regulator s office, Mr Guo has his work cut out: not just in
controlling risks, but also in persuading the wider world that it still has
China s banks pegged wrong.