Euromoney, July 24 2018
A new rule change will require Chinese banks to recognize more loans as impaired, but while big lenders will sail through, there’s trouble at the smaller end of town.
It’s symbolic of the oddness of Chinese banking that we could see a 14% increase in non-performing loans this year without asset quality actually having deteriorated at all.
How? Loan recognition standards.
It is common practice worldwide that any loan more than 90 days overdue is impaired. This also used to be the case in China until 2011, when a curious category called “overdue but not impaired” came into being, describing loans that are more than 90 days overdue and yet not recognized as non-performing loans.
This is, as UBS analyst Jason Bedford notes: “An oxymoron, since the key indicator for any bank that a loan is bad is when someone stops paying you back.”
Now, the rules are changing and these loans will have to be booked as NPLs, not Special Mention Loans, the category more commonly used for loans that are potentially troubled but not yet 90 days overdue.
Bedford has analyzed 222 banks in China and concluded that the impact of this change in loan recognition is potentially quite profound. Although assets themselves will not be getting any worse, just differently accounted for, the system-wide impact will be a 14% increase in NPLs in 2018 over 2017.
And the devil is in the detail. The big four banks will sail through this reasonably unscathed, but 95% of the impact will fall upon joint stock banks, city commercial and rural commercial banks. Rural banks will see a 33% increase, according to Bedford’s calculations. And that in turn means a lot more provisioning. Chinese banks are required to hold an NPL provisioning ratio of 150%. Bedford believes 51 banks will fall short as a consequence and that the overall provisioning shortfall for the industry is Rmb250 billion ($36.7 billion).