This has a couple of implications. First, banks are having to dedicate more earnings to loan loss-provisions. In the first half of 2018, Industrial & Commercial Bank of China allocated 43 per cent of pre-provision profit to boosting capital reserves. At Agricultural Bank of China, impairment losses were equal to 56 per cent of first-half profit, up from 41 per cent a year earlier.
Second, the figures imply that China has barely begun to scratch the surface of its bad-loan difficulties. Reported nonperforming debt ratios are low: ICBC’s was 1.53 per cent at the end of September, down from 1.56 per cent a year earlier.
But there has long been speculation about how accurate these numbers are. Chinese bank IPO prospectuses hint at liberal definitions for bad debt.
Third, the financial sector is becoming increasingly capital-constrained. Banks will find it harder to raise funds without significant public intervention. The AMCs, also known as bad banks, will also need more capital, as Bedford notes, and there’s no plan to deal with the smaller and mid-size lenders, which are the most in need of extra capital.
The major state-owned lenders have already started rolling out recapitalisation offerings. In January, Bank of China became the first to sell perpetual bonds, raising 40 billion yuan. China Citic Bank also plans to sell the debt, which counts toward tier-1 capital.
These issues may require backstopping by the People’s Bank of China to succeed. The central bank last month swapped 1.5 billion yuan of its one-year bills for perpetual bonds, the first use of a new tool aimed at increasing market acceptance of the securities and encouraging commercial lenders to sell more. Expect more such swaps to be announced.
The situation won’t inspire confidence among foreign banks that are kicking the tires of smaller local lenders they may use to enter the Chinese market. China urgently needs full and transparent disclosure of the size of its bad-debt problem, and a clear plan to address it. The longer it delays, the more expensive and painful the fix will be.