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China Bank Results Reflect Pressure from Credit Migration

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Thursday, April 05, 2018 /12:40 PM/Fitch Ratings 

Reported asset quality of Chinese banks improved in the full-year results for 2017, reflecting an improvement in economic conditions and a shift toward retail lending where non-performance is generally lower. However, improvements in core capital were limited as the migration of non-loan or off-balance-sheet credit back into bank loans - driven by tight regulations on shadow-bank and financing activities - has consumed bank capital, says Fitch Ratings. 

The credit migration is putting pressure on banks' capital, with risk-weighted assets growing faster than their assets, especially at a few mid-tier banks such as China Citic Bank and China Minsheng Bank. This meant there were only muted improvements in core capital, if any, at banks that did not raise capital externally. China Everbright Bank's common equity Tier 1 (CET1) ratio had increased to 9.56% by end-2017, up by 135bp from a year earlier, following the completion of a CNY26 billion private placement in Hong Kong in December 2017. Agricultural Bank of China recently announced plans to issue up to CNY100 billion in a private placement, which could lift its CET1 ratio by around 80bp. 

Tight liquidity pushed up interbank rates last year, allowing larger banks to earn more on their excess funds at the expense of smaller banks that borrow from the interbank market. Accordingly, the 2017 results showed stronger net interest margins (NIM) at larger banks, particularly in 4Q17. Postal Savings Bank of China saw the largest NIM rise, of 16bp. In contrast, mid-tier banks generally saw NIMs fall by 20bp-30bp in 2017, though the pace of decline moderated in 4Q17. China Merchants Bank was the mid-tier bank with the smallest NIM decline (7bp), as its large retail deposit franchise helped mitigate funding pressures. 

Management of assets and liabilities in response to higher funding costs is likely to be a key differentiating factor in bank performance in 2018. Funding costs are rising across the whole sector, but higher deposit costs have not been as large as for other sources of funding, such as interbank borrowing. Loan repricing in 2018 will also help mitigate some NIM pressure, but we expect overall profit growth to remain in the single digits. 

Retail banking was a key bright spot. Lending to households was the major driver of overall credit growth, accounting for more than half of total new loans amid tightening credit pressure in the corporate and financial sectors. This shifting focus was apparent in banks' emphasis on their strategies for fintech and e-banking in their results briefings. E-banking can enhance the cost efficiency of retail banking, but could give rise to related cyber risks if not properly monitored and managed. 

Most banks did not elaborate on whether the recent decision to lower provisioning requirements would apply to them, as they consider their current provisioning as prudent and adequate, although Fitch believes that reported NPLs do not represent the asset-quality challenges in the Chinese banking system. The regulatory provision coverage ratio target is set to be lowered to 120%-150% of NPLs, from 150%, based on criteria that reflect banks' willingness to recognise and resolve NPLs. There is likely to be more incentive for mid-tier banks to lower provision coverage, given they are under greater provisioning and capital pressure from asset migration. 

The fall in NPL and overdue loan ratios generally supported provisioning ratios in 2017. Industrial and Commercial Bank of China Limited had lifted its provisioning ratio above the regulatory minimum 150% by end-2017, having slipped below it from the beginning of 2016. All Fitch-rated Chinese commercial banks that have reported 2017 results have provision coverage ratios in excess of 150%.

 

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