China’s banking debt crisis is a ticking time bomb that must be defused with urgent financial-sector reforms

The spate of bank rescues, from Baoshang to HengFeng, is only the tip of the iceberg as slowing economic growth unearths more bad loans. The monetary fixes of the 1990s do not work without hypergrowth. The only solution? Unflinching banking-sector reforms

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Yingkou Coastal Bank was one of two banks that suffered a run on deposits after rumours spread of a funding crunch. A spate of incidents have undermined confidence in banking institutions in China since the sudden nationalisation of Baoshang Bank last May. Photo: Reuters

Published: 11:00pm, 1 Jan 2020Updated: 3:45am, 2 Jan 2020

China’s economy is entering uncharted waters of a “new normal”, with growth trapped in a downward spiral. Gross domestic product growth was an anaemic 6 per cent year on year in the third quarter last year, the lowest since 1992. Market expectations remain conservative even after the US and China agreed to the phase-one trade deal last month.

But, setting aside China’s slowdown, the real economic peril has been significantly downplayed: there is a looming crisis in China’s banking sector.

For a long time, policymakers have conspicuously given the banking sector preferential treatment. The large gap in interest rates for deposits and loans has created a lucrative cushion, making banking one of the most profitable sectors. From 1996 to 2018, China’s one-year lending interest rate was, on average, 3.1 percentage points higher than the deposit rate. At its widest, the gap was 3.6 percentage points, and has remained at 2.85 percentage points since 2014.

Along with rapid economic growth, China has experienced a decade-long banking spree. According to the China Banking Association, commercial banks made a combined net profit of 1.83 trillion yuan (US$234 billion) in 2018, about 10 times the 2004 figure. But, under the surface, the banking sector is facing mounting pressure from bad loans as economic growth slows and profits peter out.

According to the People’s Bank of China 2019 Financial Stability Report, non-performing loans at commercial banks had risen to 2.03 trillion yuan by the end of 2018, while special-mentioned loans – those potentially at risk of not performing – at financial institutions had increased to 5.27 trillion yuan. The number of non-performing loans has risen sharply since 2012 and, until the first half of 2019, showed no sign of letting up.

Furthermore, in a stress test conducted by the PBOC in the first half of 2019 on 1,171 commercial banks, 7.7 per cent were assessed as being at extreme risk and incapable of withstanding a light shock, while 13.6 per cent would fail to bear up in a financial crisis.

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