Cheap Loans Without Consideration of Adverse Credit

Chinese Banks Boom, But Bad Loan Risk is Looming

Friday, 29 August, 2008

BEIJING: China’s banking sector, once considered the weakest link in the nation’s economy, has had a spectacular first half, with one lender now touting itself as the most profitable bank in the world.

Profits have soared due to rising interest revenues and a cut in the income tax, analysts said, but they warned that a slowdown in the economy could hit borrowers’ ability to pay back loans in the second half.

“The banking sector saw sharp and better-than-expected growth in the first half, but challenges remain,” said Jin Lin, a Shanghai-based analyst with ever bright Securities in Shanghai. “In the second half, the most critical challenge for the banks will be a worsening in asset quality as ... we will be approaching a trough in the business cycle.”

Industrial and Commercial Bank of China, the nation’s top lender, said last week it had become the world’s most profitable bank in the first half after earning $9.4 billion, up 56.8 percent over the same period in 2007.

Some other banks reported even higher growth rates, with CITIC Bank posting an increase of 161.5 percent — the biggest among all Chinese lenders that have released their interim reports so far. The outstanding performance of the banking sector contrasts starkly with more moderate growth in other industries, reflecting a slowdown in the Chinese economy. The average profit growth of the 1,178 listed firms who had published their interim results by Monday was 30.9 percent.

While impressive by most standards, it was still less than half the rate of the 70 percent achieved in the first six months of 2007.

Just a decade ago, economists warned that the banks were the sector that could cause the entire Chinese house of cards to collapse. But several factors have contributed to the turnaround, analysts and economists said.

China’s tight monetary policy has strengthened the pricing power of banks amid robust demand for loans, with credit growth of 14.1 percent in the first six months of 2008.

The rate structure of the Chinese financial system has allowed banks to reap maximum benefit of the roaring loan demand, analysts said.

While banks cannot raise the one-year deposit rate above the benchmark 3.33 percent for average clients, they may hike the lending rate as high above the official 7.47 percent as they think safe without scaring customers away.

“There’s a very significant increase in net interest income,” said Charlene Chu, Fitch Ratings analyst in Beijing.

“(It’s) associated with higher pricing of loans as well as just pretty rapid growth in the loan book in the first half.” Another important reason why the first half was so lucrative was a reduction in the corporate income tax to 25 percent from 33 percent. The tax took effect in the beginning of the year and significantly brought down tax costs for the banks.

“Some banks reported more than 100 percent growth in the first half, which is partly linked to the tax cut,” said Winnie Wu, a Hong Kong-based analyst with Merrill Lynch.

“The high growth is for after-tax result. The pre-tax growth is not that high,” she said. She said some of the banks that posted 100-percent-plus after-tax profit growth probably saw a more moderate 70-to-80 percent growth in pre-tax profits. More important, tax cuts are a distinct one-off, and there are already warnings from economists that bad loans are likely to rebound in the second half and in 2009.

Domestic firms, especially those focused on exports, will feel the pinch of a slowdown in the global economy and a deceleration in Chinese growth, and may have a hard time servicing their debt. Qiu Zhicheng, an analyst with Haitong Securities in Shanghai, said some banks’ non-performing loan ratios have already started to rise in the second quarter, and the increase was expected to be more noticeable at year’s end. “Both the real estate sector and the manufacturing industry will have problems,” he said. “Banks’ growth rate will slow down gradually in the second half and by a larger margin next year.”

Investment in overseas assets by Chinese banks, such as their holdings of bonds in two struggling US mortgage finance giants Freddie Mac and Fannie Mae, is another area where risks could emerge.

Fitch’s Chu said the exposure seen so far was relatively small compared to the size of the banks, but the overall impact on China’s banking sector remained unclear. “We need to wait and see — there are big entities like Bank of China that are yet to announce (their exposure),” she said.

Source : http://www.dailytimes.com.pk/