The Asia Global Payment Summit. Bali, Indonesia. 10-11 October 2019

New Recognition Standards Will Boost Non-performing Loans of Chinese Banks

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Changes to loan recognition standards could result in a 14% leap in the non-performing assets of Chinese banks in 2018, leading to a severe shortfall in provisioning.

Standard international practice for the banking sector is for any loan more than 90 days overdue to be categorised as impaired.

China launched a designation referred to as “overdue but not impaired” in 2011, however, that covered loans overdue for more than three months, enabling them to dodge categorisation as non-performing assets.

According to UBS analyst Jason Bedford in a report from Euromoney this category is “an oxymoron, since the key indicator for any bank that a loan is bad is when someone stops paying you back.”

China’s unique rules covering the categorisation of defective loans are now changing, however, in a move which is expected to dramatically boost the NPL ratio of its banks.

Under the changes assets which were previously categorised as “Special Mention Loans” will instead be directly designated as NPL’s.

Bedford conducted an analysis of 222 banks in China which concluded that NPL’s will surge by 14% in 2018 compared to 2017 as a result of the new recognition standards.

The big four state-owned banks will remain largely untainted by the shift, with smaller lenders set to weather the brunt of change.

Bedford’s analysis sees joint-stock banks, municipal commercial banks and rural commercial banks bearing 95% of the impact, with rural banks expected to post a 33% NPL increase.

This NPL surge will require greater provisioning, with Chinese banks currently required to maintain an NPL provisioning ratio of 150%.

Bedford expects 51 banks to fall short of this requirement in the wake of the NPL rise, with a total sector-wide shortfall of 250 billion yuan (approx. USD$36.7 billion).

China’s regional lenders have already seen a record volume of credit ratings downgrades this year, in the wake of a deleveraging campaign and shadow banking crackdown which have severely constricted liquidity.

While smaller banks are expected to suffer from onerous short-term pain as a result of the loan recognition shift, the move will at least bring more accuracy and transparency to the state of the Chinese banking sector.

Analysts argue, however, that even these changes will fail to provide a true reflection of the health of the sector, given the copious size of Chinese shadow banking activity.

CLSA says that the loan recognition shift will only bring the official level of system-wide bad debt to 2%, when a more realistic reading is around 15% given the scope of the shadow banking sector.

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