China Credit Risks Emerging, But Remain Isolated

As China’s stability becomes less certain, credit risks are coming back into focus.

Market analysts believe the rise in non-performing loans (NPLs) is contained at the moment, however China still has less room than last year to tolerate over-leveraging

“There is currently divergence in the credit situation of China’s banks,” Jeff Ng, head of Asia Research with Continuum Economics wrote in a note to clients on July 24. “Specifically, smaller banks are becoming particularly vulnerable to credit risks as the country’s financial stability is hit by global and local tensions.”

Chinese authorities have targeted deleveraging and sustainable lending, it is the country’s smaller banks that have been hit the hardest. This us attributed to a lack of deposits and less accessible funding. With the need to seek higher returns for higher cost funding, smaller banks have now had to take on more risks.

So far, China’s official NPL ratio in has remained manageable–hovering at around 1.5% for large commercial banks and 3.3% for rural commercial banks. “However, we see some isolated risks for rural commercial banks, which have seen their NPL ratios rise since the start of 2017,” Ng adds.

Credit rating agencies have downgraded more than five small banks since the beginning of this year. Chinese authorities have also been slow to react to inflated credit ratings for some banks. At the same time, domestic credit agencies have been caught off guard as a couple of investment-grade companies have defaulted on their obligations in the bond market.

Ng explains that all of these factors have contributed to the People’s Bank of China cutting its reserve requirement ratio, as well as injecting liquidity into the financial system this year in order to maintain stability. “We expect to see more of these measures from the Bank in 2018-19.”