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28/07/2020 14:01

China banks' potential capital gap still large - Fitch

[ET Net News Agency, 28 July 2020] China's efforts to improve the financial system's
credit efficiency are set to experience a temporary setback in 2020 as a result of the
shock from the coronavirus pandemic, but banks' potential capital shortfall associated
with credit at higher risk of impairment (inefficient credit) has stabilised in recent
years, said Fitch Ratings.
Fitch examined the potential repercussions for the banking sector under a hypothetical
scenario analysis in which a proportion of inefficient credit was viewed as impaired,
based on end-2019 data. The credit rating agency estimated that inefficient credit could
have been as high as 15%-22% of total credit at end-2019, and this could result in a
potential system-wide capital gap of between CNY9.5 trillion and CNY19.5 trillion, or
10%-20% of GDP.
The scenario analysis does not represent Fitch's base case but nonetheless suggests that
reported system-wide asset-quality metrics may understate the level of risk facing the
banking sector.
The potential capital gap is broadly similar to that at end-2015, when it stood at
around 10%-19% of GDP, despite rapid growth in credit since then. This outcome is more
positive than the further deterioration Fitch had anticipated when it last conducted such
an assessment, in 2016.
The stabilisation of the potential credit gap reflects regulatory tightening since 2017,
consistent banking sector profitability and accelerating resolution of non-performing
loans (NPLs), as well as banks' risk-reduction efforts and increased capital issuance.
Fitch defined inefficient credit by comparing the credit growth relative to GDP against
a base period of 2005-2008, which was assumed to represent a period of relatively
efficient credit growth. The stock of inefficient credit still presents a large credit
overhang for Chinese banks, but a decline in 'shadow-banking' activities and corporate
deleveraging efforts resulted in improved credit efficiency over 2016-2019 relative to
This improvement will be eroded significantly in 2020. Weak economic growth and a modest
acceleration in credit - both trends associated with the impact of the pandemic and
efforts to counter it - will push China's credit efficiency ratio to its lowest level
since 2015.
Fitch expects financial system leverage to reach around 265% of GDP by end-2020.
However, as the economy recovers it should stabilise in 2021. Combined with a resumption
of official efforts to curb shadow-banking activities and a greater bank focus on lending
to retail sectors, this should help to restore credit efficiency, and is consistent with
Fitch's stable outlook for the banking system operating environment assessment of 'bb+'.
The findings highlight the importance of improving credit efficiency if China is to
resolve its credit overhang. Fitch-rated Chinese commercial banks wrote off or disposed of
at least CNY2.5 trillion worth of bad loans during 2017-2019, equivalent to around
0.8%-1.2% of their total loans annually over the same period. The country will still face
challenges in sustaining the improvement in credit efficiency, amid US-China tensions and
the pandemic, but signs of gradual domestic economic recovery in China should mitigate the
need for excessive bank lending this year.
The outlook on Chinese banks' Issuer Default Ratings will remain stable assuming no
negative action on China's sovereign rating (A+/Stable), as they are all sovereign
support-driven. However, if the government's policy response to the pandemic leads to a
sustained acceleration in system leverage it could be credit negative for China's
operating environment assessment, which could in turn affect Chinese banks' standalone
Viability Ratings. (KL)

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