The impact of Covid-19 and trade war on China’s banking sector
China’s economy, which was already slowing down before the Covid-19 pandemic, has been hit hard by the health crisis and the trade war with the US. The country’s banking sector, which is the largest in the world by assets, is facing a serious challenge as the number of bad loans has surged to a record high.
According to the China Banking and Insurance Regulatory Commission (CBIRC), the non-performing loan (NPL) ratio of Chinese banks reached 2.08% at the end of September 2023, up from 1.86% at the end of 2022. The total amount of NPLs stood at 4.6 trillion yuan (£520 billion), an increase of 21.5% year-on-year.
The CBIRC also revealed that the amount of special-mention loans, which are loans that are not yet classified as NPLs but have potential credit risks, rose by 13.3% year-on-year to 4.4 trillion yuan (£500 billion) at the end of September 2023. The special-mention loan ratio was 3.18%, up from 3.16% at the end of 2022.
The rise in bad loans reflects the impact of the Covid-19 pandemic, which has disrupted the economic activities and reduced the income of many businesses and households. The CBIRC estimated that the pandemic has caused a direct loss of 1.5 trillion yuan (£170 billion) to the banking sector in 2022.
The trade war with the US, which has imposed tariffs on hundreds of billions of dollars worth of Chinese goods, has also hurt the export-oriented sectors of the Chinese economy, such as manufacturing, technology and agriculture. The trade tensions have also increased the uncertainty and risk aversion of the global financial markets, making it harder for Chinese firms to access foreign capital.
The measures taken by the Chinese authorities to support the banking sector
To cope with the rising bad loans and the economic slowdown, the Chinese authorities have taken a series of measures to support the banking sector and ease the financial pressure on the borrowers.
One of the main measures is the implementation of the deferred repayment policy, which allows banks to postpone the repayment of principal and interest for some loans that are due between January 2020 and June 2023. The policy covers loans to small and medium-sized enterprises (SMEs), individual businesses, farmers and consumers, as well as some loans to large enterprises that are affected by the pandemic.
According to the CBIRC, the deferred repayment policy has benefited more than 3.7 million enterprises and 460 million individuals, with a total amount of 19.5 trillion yuan (£2.2 trillion) as of the end of September 2023. The policy has helped to reduce the NPL ratio by 0.7 percentage points and the special-mention loan ratio by 0.9 percentage points.
Another measure is the provision of low-cost funding to the banks, especially the small and medium-sized banks, which are more vulnerable to the credit risks and liquidity shocks. The People’s Bank of China (PBOC), the central bank, has injected trillions of yuan into the banking system through various monetary policy tools, such as the medium-term lending facility (MLF), the targeted medium-term lending facility (TMLF) and the re-lending and re-discounting programs.
The PBOC has also cut the reserve requirement ratio (RRR) for banks several times since 2020, releasing more than 2 trillion yuan (£230 billion) of liquidity into the market. The RRR is the percentage of deposits that banks have to keep as reserves at the central bank. The lower the RRR, the more money the banks can lend out.
In addition, the CBIRC has encouraged the banks to increase their lending to the real economy, especially to the SMEs, which are the backbone of the Chinese economy and the main source of employment. The CBIRC has set a target for the banks to increase their inclusive loans to SMEs by more than 30% in 2023, and has offered incentives and rewards to the banks that meet the target.
The CBIRC has also urged the banks to dispose of their bad loans in an orderly manner, and to replenish their capital and improve their risk management. The CBIRC has allowed the banks to issue various types of capital instruments, such as perpetual bonds, convertible bonds and preferred shares, to raise funds from the market. The CBIRC has also supported the establishment of asset management companies (AMCs) and debt-for-equity swap platforms to help the banks offload their bad assets.
The challenges and risks facing the Chinese banking sector
Despite the measures taken by the Chinese authorities, the banking sector still faces many challenges and risks in the near future.
One of the challenges is the uncertainty of the economic recovery, which depends on the effectiveness of the pandemic control, the progress of the vaccination program, and the external demand. The International Monetary Fund (IMF) has projected that China’s GDP growth will slow down from 8.1% in 2022 to 5.6% in 2023, below the potential growth rate of 6%.
Another challenge is the pressure of the asset quality deterioration, which may worsen as the deferred repayment policy expires and the borrowers have to resume their repayments. The CBIRC has warned that the NPL ratio may rise further in the fourth quarter of 2023 and the first half of 2024, and that the banks need to prepare for the possible increase in credit losses.
A third challenge is the competition from the fintech sector, which has been growing rapidly in China and offering innovative and convenient financial services to the customers. The fintech sector, which includes online platforms, digital banks and payment systems, has been challenging the traditional banking sector in terms of market share, profitability and customer loyalty.
A fourth challenge is the regulation and supervision of the banking sector, which has become more stringent and complex in recent years. The Chinese authorities have introduced a series of new rules and standards to enhance the financial stability, consumer protection and market discipline of the banking sector. The banks have to comply with the new requirements on capital adequacy, liquidity, leverage, governance, disclosure and resolution.
The banking sector also faces some potential risks that may trigger a systemic crisis if not handled properly. One of the risks is the shadow banking sector, which refers to the non-bank financial intermediaries that operate outside the regulatory framework and offer high-risk and high-return products to the investors. The shadow banking sector, which includes trust companies, wealth management products, peer-to-peer lending platforms and local government financing vehicles, has been a source of financial instability and contagion in the past.
Another risk is the debt level of the Chinese economy, which has reached a high level of 280% of GDP as of the end of 2022, according to the IMF. The high debt level, which is mainly driven by the corporate and local government sectors, poses a threat to the financial stability and fiscal sustainability of the Chinese economy. The debt problem may also constrain the fiscal and monetary policy space of the Chinese authorities in the event of a shock.
A third risk is the external vulnerability of the Chinese economy, which is exposed to the fluctuations of the global financial markets and the geopolitical tensions. The Chinese economy relies heavily on the external trade and investment, which may be affected by the changes in the global demand, supply chains, exchange rates and interest rates. The Chinese economy also faces the challenges of the US-China trade war, the sanctions and restrictions imposed by the US and its allies, and the disputes over the issues such as Taiwan, Hong Kong, Xinjiang and the South China Sea.
China’s economy, which is the second largest in the world, is facing a £70 billion crisis as its banking sector struggles to cope with the rising bad loans amid the Covid-19 pandemic and the trade war with the US. The Chinese authorities have taken a series of measures to support the banking sector and ease the financial pressure on the borrowers, but the banking sector still faces many challenges and risks in the near future. The performance and stability of the banking sector will have a significant impact on the growth and development of the Chinese economy and the global economy.
