China is ready for any banking crisis that may come

Recent articles warn that China will soon face a banking crisis. Bad debt will cause Chinese banks to tumble, they say, with shock felt throughout the world. But these predictions misjudge the capacity of the Chinese government.

Beware 2016, PwC cautions China’s banks

Looming trouble doesn’t show in official data: non-performing loans comprise just 1.75 per cent of reported loans, a reasonable figure by international standards. Analysts worry the figures understate the problem, but Chinese banks have already taken precautions. Their loan-loss provisions are currently about 200 per cent of their non-performing loans; in the rest of the world, 100 per cent is considered solid protection. Even if such loans were to double, China is ready.

Still, there is concern the shocks may deepen. Some analysts believe that “special mention” loans may become uncollectible, and estimates of non-performing loans rise to nearly six times the current reported level.

Such reports often imply that all problem loans will become complete losses, which would be far from historical patterns. Non-performing loans are grouped into three categories – substandard, doubtful, and loss – and many problem loans, especially those classed as special mention and substandard, have been collected over time. Especially in a growing economy, some troubled companies recover, property values increase, and hidden assets are discovered, all leading to recoveries of at least portions of loans that had been troubled or even written off.

Chinese banks are set to take on more bad loans as the economy slows

But what if the situation turns much worse? The central government has the ability to prevent problems from becoming systemic, by absorbing a portion of the loan risk. In 1999 and 2000, it assumed non-performing loans from the largest banks, using government bonds and newly created asset management companies. The programme worked extremely well, and the banks then supported the rapidly growing economy. Now, after years of economic growth, those bonds are insignificant in China’s overall financial system.

In such a new plan, the central government could essentially say: “The banking system supports the growth of the Chinese economy, and now we have decided that the government will cover a portion of the risk taken in providing such support. Western countries used direct government funding to counter their financial crises, and we will now step in, in a way appropriate to China, to assure stability.”