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Bad medicine

23 March 2016 By Peter Thal Larsen

China’s banks are getting ready to undergo some questionable cosmetic surgery. Letting big lenders hold fewer provisions against bad loans will make earnings look prettier but undermine balance sheets – and give investors another reason to avoid Chinese bank shares.

China has a growing bad loan headache: credits officially classed as non-performing reached 1.67 percent of the total at the end of 2015, according to the China Banking Regulatory Commission, up from 1.25 percent a year earlier. Add in other doubtful loans and the total rises to more than 5 percent. Political pressure to keep helping troubled borrowers mean these figures almost certainly understate the problem.

Though banks have increased bad loan provisions, these have not kept pace with the deterioration in credit. At the end of 2014, the Chinese banking industry’s stock of allowances was 232 percent of bad loans. This had fallen to 181 percent by the end of last year. Some institutions are getting close to the 150 percent minimum ratio demanded by regulators. Bank of China’s provisions had fallen to 154 percent of its bad loan exposure at the end of September.

The prudent response would be to demand bigger provisions, even if this dents reported earnings. Instead, it seems regulators have opted to conceal the problem. According to Caixin, seven institutions including the country’s four biggest state-owned banks may be allowed to let their bad debt provision ratios fall as low as 130 percent.

Chinese bankers will doubtless argue that the current rules are excessively tough. After all, the loss on a bad loan cannot exceed 100 percent of its original value and banks are rarely left with nothing. Besides, many Western lenders operate with much lower ratios.

However, this analysis ignores the fact that Chinese banks are still eagerly handing out new loans, some of which will inevitably go bad, while ramping up their exposure to short-term investments that may conceal credit problems. It also suggests a worrying willingness by regulators to bend the rules at the first sign of trouble. Investors are already sceptical of what lurks on Chinese banks’ balance sheets. The latest facelift will not fool them.


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