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China’s Banks Face Growing Risks from Property Crisis

The ongoing crisis in China’s property sector, which has seen dozens of developers default or miss payments on their debts, is putting pressure on the country’s banking system, which holds nearly 40 percent of all real estate loans. Regulators are trying to contain the risks and prevent a systemic collapse, but the challenges are formidable.

How big is the problem?

China’s property sector accounts for about a quarter of the country’s GDP and employs millions of people. It also relies heavily on borrowing, both from domestic and foreign sources. According to the Bank for International Settlements, China’s property developers had a total debt of $1.4 trillion at the end of 2022, equivalent to 9.7 percent of China’s GDP.

The most prominent case of distress is China Evergrande, the world’s most indebted developer, which owes more than $300 billion to various creditors, including banks, bondholders, suppliers and homebuyers. Evergrande has been struggling to meet its obligations since last year, and has repeatedly missed interest payments on its bonds. Other developers, such as Fantasia Holdings, Sinic Holdings and Modern Land, have also defaulted or delayed payments in recent months.

The defaults have triggered a loss of confidence in the sector, leading to a sharp drop in sales, prices and new construction. This has reduced the cash flow and profitability of developers, making it harder for them to repay their debts or raise new funds. The situation has also created a negative feedback loop, as lower property values erode the collateral value of loans and increase the risk of defaults.

China’s Banks Face Growing Risks from Property Crisis

How are banks affected?

China’s banks are heavily exposed to the property sector, both directly and indirectly. According to official data, banks had outstanding loans of 55.6 trillion yuan ($8.6 trillion) to the property sector at the end of June 2023, accounting for 39 percent of their total loans. Of this amount, 31.4 trillion yuan ($4.9 trillion) were mortgages, 14.7 trillion yuan ($2.3 trillion) were loans to developers, and 9.5 trillion yuan ($1.5 trillion) were loans to local government financing vehicles (LGFVs), which are often involved in infrastructure and real estate projects.

Banks also have exposure to the property sector through other channels, such as wealth management products (WMPs), trust loans, bonds and interbank lending. According to estimates by UBS, China’s banks had a total exposure of 78.8 trillion yuan ($12.2 trillion) to the property sector at the end of 2022, equivalent to 72 percent of their equity.

The rising defaults and deteriorating conditions in the property sector have increased the pressure on banks’ asset quality and profitability. According to data from the China Banking and Insurance Regulatory Commission (CBIRC), banks’ non-performing loan (NPL) ratio for the property sector rose from 0.87 percent at the end of 2022 to 0.94 percent at the end of June 2023, while their provision coverage ratio fell from 212 percent to 204 percent over the same period.

Banks’ net interest margin (NIM), a measure of their profitability, also declined from 2.12 percent at the end of 2022 to 2.07 percent at the end of June 2023, partly due to lower lending rates and higher funding costs amid tighter liquidity conditions.

How are regulators responding?

China’s regulators have been trying to rein in the risks and prevent a systemic crisis in the banking system. They have adopted a range of measures, such as:

  • Imposing stricter rules on lending and borrowing by developers and LGFVs, such as the “three red lines” policy that limits their leverage ratios.
  • Conducting stress tests on banks’ balance sheets and capital adequacy under various scenarios of property market shocks.
  • Providing liquidity support and regulatory forbearance to banks that face temporary difficulties due to property-related exposures.
  • Encouraging debt restructuring and resolution for distressed developers, while avoiding blanket bailouts or moral hazard.
  • Promoting social stability and protecting the rights and interests of homebuyers, suppliers and other stakeholders affected by developer defaults.

Regulators have also signaled that they will not tolerate any disorderly collapse or contagion in the property sector, and that they will intervene if necessary to safeguard financial stability and economic growth.

What are the challenges and outlook?

Despite these efforts, regulators face significant challenges in managing the risks and resolving the problems in the property sector. Some of these challenges include:

  • Balancing between deleveraging and stimulating the economy amid slowing growth and rising inflation.
  • Coordinating between different regulatory agencies and local governments with divergent interests and incentives.
  • Communicating effectively with market participants and maintaining confidence and expectations.
  • Dealing with potential legal disputes and social unrest arising from developer defaults.
  • Coping with external shocks and uncertainties, such as the Covid-19 pandemic, geopolitical tensions and global financial volatility.

The outlook for China’s property sector and banking system remains uncertain and depends on various factors, such as the pace and extent of policy adjustments, the behavior and response of market players, and the evolution of external conditions. While a fast-moving and systemic crisis is unlikely, given the government’s extensive control and intervention capabilities, the risks and challenges are still considerable and warrant close attention and vigilance.

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