Previously, in Introducing China's Banking Sector, we explored the history of China's banking sector over the past 120 years and provided an overview of how the country's banking system is currently structured. Subsequently, in Introducing China's Largest Banks, we introduced China's ten largest banks based on 2022 total assets, including each bank's history, relative size ranking, and ownership structure. We then compared the ten banks financially in Comparing China's Largest Banks, including a revenue breakdown analysis based on revenue driver, business type, and geography, as well as a profitability analysis based on operating and net profit margins.
In this article, we conclude our China Banking series with a brief discussion of some key factors that may affect the future of China's banking industry.
China Banking Series
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A Low Interest Rate Environment In The Short To Medium Term
China's loan prime rate (贷款市场报价利率)* has been on a generally declining trend over the past ten years, with the declines during the most recent, post-COVID years being presumably triggered by the country's relatively stagnant economy compared with the rapid growth seen in pre-pandemic years. This declining interest rate environment has taken a toll on Chinese banks, which tend to be heavily reliant on net interest income (see Comparing China's Largest Banks), with net interest margins declining from the 2.2% to nearly 3% range to the 1.5% to 2% range over the past decade for China's ten largest banks. Given that China's economic growth is still relatively stagnant, we anticipate that this low interest rate environment will persist in the short to medium term, thereby perhaps further reducing banks' net interest margins.
*the loan prime rate is the most widely used benchmark interest rate in China. It represents the average of the most preferential lending rates offered by commercial banks to their prime clients (see here for a more detailed explanation). China does not have an official
] policy interest rate, but the central bank is able to influence the loan prime rate given the predominantly state-owned nature of the country's banking system.
Note: the loan prime rate was launched in late 2013. Prior to the loan prime rate, benchmark lending rates were directly issued by the People's Bank of China.
Note: most of the increases in net interest margin in 2018 and 2019 were due to a regulatory financial reporting change in 2020 which reclassified credit card installment income from fee and commission income to interest income, with data restated retrospectively
Additionally, policy risks may exist which could further impact the net interest margins of Chinese banks. For example, in September 2023, five of the six nation-owned banks (国有银行) (see Introducing China's Banking Sector) lowered interest rates on existing mortgages for first-home loans as part of a regulatory effort to support property buyers.
Furthermore, should the Chinese economy continue to stagnate, it is possible that banks' fee and commission income may also be affected.
Unwavering Traditional Business Models
China's banking system is dominated by state-owned banks with relatively traditional business models compared with banks in the US or Eurozone. Specifically, Chinese banks tend to focus more on traditional banking activities, such as lending and deposit-taking, and are heavily reliant on net interest income as opposed to other income sources such as fee and commission income or trading activities. We expect the traditional business models of Chinese banks to persist without significant changes going forward. Generally speaking, it is more beneficial for state-owned bank managers to be more risk-averse and promote financial stability rather than to take excessive risks with more uncertain consequences.
How Exposed Are China's Largest Banks To The Real Estate Sector?
We conclude this article by examining how exposed China's largest banks are to the real estate sector, a topic of concern among many market participants. To do so, we examine the loan breakdown data reported by China's ten largest banks. Specifically, we look at the percentage of total loans granted to corporate real estate borrowers and retail mortgage borrowers, as well as the non-performing loan (NPL) ratios of the two loan types. Undoubtedly, the two loan types do not fully capture each bank's exposure to the real estate market, since other exposures may exist, such as through investment products, and other forms of risk may also exist, such as correlated defaults and contagion effects.
>> Corporate Real Estate Loans Accounted For 3% To 7.8% Of Banks' Total Loans In 1H2023
In the first half of 2023, loans to corporate borrowers in the real estate sector accounted for 3% to 7.8% of total loans and advances to customers for the ten largest Chinese banks. Industrial Bank had the highest percentage of loans to corporate real estate borrowers at 7.8% of total loans, followed by the Bank of China at 7.6%, the Bank of Communications at 6.5%, SPD Bank at 6.4%, China Merchants Bank at 5.6%, China CITIC Bank at 5.2%, the Agricultural Bank of China and ICBC at 4.1%, China Construction Bank at 3.6%, and lastly, the Postal Savings Bank of China (PSBC) at 3.0%. PSBC's relatively low proportion of loans to real estate companies is consistent with the bank's primary goal of providing financial services to retail consumers and SMEs in less developed areas (see Introducing China's Largest Banks for a summary of each bank's business model).
There are variations in trend between the ten banks from 2017 to the first half of 2023, with six of the banks (the Agricultural Bank of China, China Merchants Bank, China CITIC Bank, ICBC, and SPD Bank) showing a general decrease in the percentage of corporate real estate loans as a proportion of total loans and advances to customers. In contrast, the percentage proportion of corporate real estate loans remained relatively constant for the Bank of China and China Construction Bank, and increased for the Bank of Communications, Industrial Bank, and PSBC.
Note: China Construction Bank only reports data for mainland China and the reported number does not take subsidiaries into account
Note: PSBC only reports data to the nearest percentage
>> Corporate Real Estate Loan NPL Ratios Ranged From 0.81% To 5.8% In 1H2023
In the first half of 2023, reported non-performing loan (NPL) ratios for corporate real estate loans ranged between 0.8% to 5.8%. Interestingly, Industrial Bank, which had the highest percentage of loans to real estate companies during the same time period, reported the lowest NPL ratio for real estate borrowers at only 0.8%. PSBC had the second lowest NPL at 1.0%, followed by SPD Bank at 2.9%, the Bank of Communications at 3.4%, and China Construction Bank at 4.8%. The remaining five banks all had NPL ratios in the 5% range, with the Bank of China reporting an NPL ratio of 5.1%, followed by China CITIC Bank and ICBC at 5.3%, China Merchants Bank at 5.5%, and the Agricultural Bank of China with the highest reported NPL ratio of 5.8%.
All ten banks experienced an increase in corporate real estate NPL ratios over the past six and a half years except for Industrial Bank, which had a fluctuating NPL ratio between 0.7% to 1.3%. Comparing the first half of 2023 with the year ended 2022, we see that five of the ten banks (the Agricultural Bank of China, the Bank of Communications, China Construction Bank, China Merchants Bank, and China CITIC Bank) had higher NPL ratios in the first half of 2023 than in 2022, while the remaining five banks had lower NPL ratios in the first half of 2023 compared with in 2022.
Note: the Bank of China and ICBC only report data for mainland China
Note: China Construction Bank only reports data for mainland China and the reported number does not take subsidiaries into account
>> Mortgage Loans Accounted For 17.2% To 30% Of Banks' Total Loans In 1H2023
In the first half of 2023, mortgage loans to individual borrowers accounted for 17.2% to 30% of total loans and advances to customers for the ten largest Chinese banks. PSBC had the highest percentage of mortgage loans to individual borrowers at 30% of total loans, consistent with the bank's heavy emphasis on retail banking (discussed in Comparing China's Largest Banks). China Construction Bank had the second highest percentage of mortgage loans at 27.7% of total loans, followed by the Bank of China at 25.3%, ICBC at 25.2%, the Agricultural Bank of China at 24.4%, China Merchants Bank at 21.7%, Industrial Bank at 20.8%, the Bank of Communications at 19.2%, China CITIC Bank at 18.3%, and lastly, SPD Bank at 17.2%.
The ten banks exhibit similar trends in mortgage loan percentage from 2017 to the first half of 2023, with peaks between 2019 to 2021 and a generally declining trend in 2022 and the first half of 2023.
Note: China Construction Bank only reports data for mainland China and the reported number does not take subsidiaries into account
Note: PSBC only reports data to the nearest percent
>> Mortgage Loan NPL Ratios Were In The 0.4% To 0.6% Range In 1H2023
All banks experienced slight increases in mortgage NPL ratio from 2017 to the first half of 2023, with cross-sectional data showing very little variability of only 0.2% across banks each year. In the first half of 2023, the NPL ratios of mortgage loans to individual borrowers ranged from 0.4% to 0.6%.
Note: the Agricultural Bank of China and the Bank of China only report data for mainland China
Note: China Construction Bank only reports data for mainland China and the reported number does not take subsidiaries into account
Based on our analysis of China's ten largest banks (which accounted for 53% of total assets in China's banking system in 2022), it can perhaps be argued that the possibility of a severe, real estate-induced financial crisis is less than what is reflected in the general market sentiment. Banks' exposures to corporate real estate borrowers are in the relatively low to moderate range, with NPL ratios that have risen but are still at moderate levels. Although mortgage loans do account for a significant weight of banks' total loans, the NPL ratios of these mortgage loans are still at very low levels.
Additionally, Chinese banks generally maintain what could be considered as reasonable NPL coverage ratios, with a sector-wide average of 206.1% in Q2 2023, compared with an average reserve coverage ratio of 224.8% for FDIC-insured banks in the US (see here) and an NPL coverage ratio in the low 40% range for the Eurozone over the same time period (the ECB reports a graph but not an exact number for Q2 2023 - see here).
Note: data from individual banks are from 1H2023, while country and regional averages are from Q2 2023
We think that the possibility of Chinese banks experiencing a crisis that is exacerbated by complex and opaque derivatives markets (such as during the global financial crisis of 2007-2008) is unlikely given that Chinese banks are typically more risk-averse and face greater restrictions on investing in such financial products.
Nevertheless, our analysis is brief and does not take into account other exposures or risk factors except those discussed above. For example, it is also possible that Chinese banks may be trying to postpone a crisis by delaying the recognition of bad loans.
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