A Third of Chinese Banks Fail to Generate Economic Value: McKinsey Report

A new report from consulting firm McKinsey & Co. claims that a third of Chinese banks failed to produce any economic profits last year as domestic operating conditions continue to become more challenging.

In 2016 13 out of 40 major Chinese banks monitored by McKinsey failed to generate any economic value added (EVA) – a measure of financial performance which calculates residual wealth by deducting the cost of capital from operating profit.

According to the report China’s banking sector faced an especially challenging environment last year, severely constraining their ability to create value.

‘Chinese banks are faced with three grey rhinos,” said global senior partner Joseph Luc Nagi in the report. “They are narrowing interest margins amid interest rate liberalisation, heavier burdens from non-performing loans and the deleveraging challenge amid stricter supervision from regulators.”

The 40 lenders monitored by McKinsey generated a combined economic profit of 333.5 billion yuan (USD$50.27 billion) in 2016, for a year-on-year decline of 32%, while their average risk adjusted return on capital fell to 20.4%, from 18.2% in 2015.

According to the report ailing profits are primarily the result of high levels of lending to the corporate sector, in particular state-owned enterprises.

Ngai said that the operating environment will continue to worsen in the near-term as Beijing continues to pursues efforts to deleverage the Chinese economy.

“[Bank] prospects are increasingly uncertain, and the next three years will be a watershed when the bad performers will become worse.”

The three leading creators of value were all big state-owned banks, including the Industrial and Commercial Bank of China, China Construction Bank and Bank of China.

The three worst performers were Postal Savings Bank of China, China Guangfa Bank and China Citic Bank.

Other observers beg to differ with McKinsey’s pessimistic take on China’s banking sector, such as Industrial Bank analyst Qiao Yongyuan.

“The pessimism is not in accordance with the fundamentals of Chinese banks,” said Qiao in a note published on Tuesday.

Qiao points out that Chinese banks have seen interest margins improve this year on the back of the rising rates induced by Beijing’s deleveraging campaign.

China’s economy has outperformed expectations in 2017, while the average non-performing loan ratio of Chinese commercial banks held steady in the first half at 1.74%.

Qiao further points out that McKinsey’s model made use of an excessively demanding 15% required return, when use of the more realistic figure of 7-9% makes all but one of the 40 banks monitored a profit-generating concern.

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