Banking in China (part II): Strong results but a frail health
Chinese banks faced little or no distress during the turmoil of the financial crisis and are becoming more and more assertive on the international scene, particularly on the African continent. However, growing concerns weigh on their fundamentals. The level of credit allocation as well as an increasing fear for a Chinese housing bubble, suggest that the sector could soon find itself in difficulty.
A powerful and growing sector
While the financial crisis was shaking up the Western markets, China's four largest banks saw their profits rising by more than 16% between 2008 and 2009. The third largest bank, Bank of China, even saw its net profits increasing by almost 30% over the same period.
2010 also started off hopeful to say the least. Agricultural Bank of China posted a record increase of over 40% of its profit in the first half of 2010, a trend confirmed by the strong performance by its peers and presented in the table below:
Building on these excellent results, Chinese banks are also working in parallel on international expansion. Without posing a real threat to other major banks in the U.S. or Europe at the moment, they are slowly gaining a foothold on other continents, notably in Africa where follow Chinese companies making large investments.
As such, in October 2007 the Industrial and Commercial Bank of China announced it was taking a stake in the capital of the largest South African bank, Standard Bank. Lately, it was announced they would start operations in Canada, following the acquisition of the Canadian branch of Bank of East Asia by acquiring a stake of up to 70% in January 2010. Bank of China, already present in 29 countries worldwide, has begun negotiations with Cape Verde to sign cooperation agreements that would allow it to open branches in both countries. In March, a cooperation agreement was signed with the International Bank of Mozambique and a branch was opened in Brazil in July.
The China Construction Bank is already present in many countries such as the U.S.A., Germany and Australia. Finally, the Agricultural Bank of China is established in 8 countries while the ICBC already offers its services in over 20 countries.
The downside: overheating credit
Despite these excellent figures, China is getting nervous about a possible credit burst, much like in the U.S in 2008. Proof if any were needed, is the intervention of the surveillance commission of the Chinese banking system in January 2010, in which banks were asked to assure a stable and measured growth of credit. In China, loans have indeed boomed in 2009 reaching 9.5 trillion Yuan (996 billion Euros) or twice the amount reached in 2008. Consequently the Chinese government aimed at limiting debt expansion in 2010 to about 7.5 trillion Yuan (773 billion Euros). This ceiling was overshot; in 2010 Yuan-denominated lending in China reached 7.95 trillion Yuan (870 billion Euros).
To meet requirements, Chinese banks are suspected of undervaluing their current loans and performing massive securitization operations. Since return on these types of financing structures is particularly high, demand is high. According to Fitch Ratings, in the first half of 2010, more than 2.3 trillion Yuan (250 billion Euros) in loans have been transformed into investment products through this method. If Chinese banks officially claim that they have written loans for 4.6 trillion Yuan (510 billion Euros) over the same period, Fitch Ratings believes that this amount could be closer to 5.9 trillion Yuan (650 billion Euros).
A real-estate bubble in the making
Besides Chinese banks must now brace themselves for a looming real-estate bubble that has been formed in recent year on the housing market. Since 2009, economists and experts worldwide have been raising doubts on the Chinese real estate market, claiming that it is overvalued. To survive the crisis, China prepared a 4000 Billion Yuan (440 billion Euros) recovery plan and encouraged lending.
In the event that the real-estate market would go down, the degree of debt of local governments would become very worrying. They are forbidden by law to lend money directly to banks, so they circumvented this constraint by setting up near to 8000 mutual funds that carry an estimated 7700 billion Yuan of debt.
The government has introduced measures aiming at correcting the market. These restrictive measures have initially helped to stabilize the property market since no increase occurred since May 2010. However the latest figure show a 0.5% increase in prices in the sector in September 2010 compared to the previous month, suggesting that the market hasn't peaked yet. According to Bloomberg, property prices in china should continue to increase by about 5% in 2011. Real estate prices in Hong Kong should rise by about 12% in 2011 after rising 18% in 2010, mostly driven by speculation. China has never experienced declining housing prices with most economics agents assuming that the rise will continue.
Therefore there is still a bit of time left to the Chinese government to take the necessary measures to secure the banks' balance sheets. A downturn of the real-estate market would probably affect the entire world economy. Indeed, the construction boom has been the driving force behind China's growth in recent years. A slowdown in this market would negatively impact the Chinese economy, leading to international investors fleeing from Chinese stocks. Industries and countries that are highly exposed to China such as Australia and Canada through the mining industry, Japan, the U.S.A and Europe through major Chinese investments in their industries, would then suffer from contagion.