China's Banks Face $6 Trillion Coronavirus Cataclysm If Epidemic Is Not Contained Soon


In a little noticed post back in November, we reported that as part of a stress test conducted by China's central bank in the first half of 2019, 30 medium- and large-sized banks were tested; In the base-case scenario, assuming GDP growth dropped to 5.3% - nine out of 30 major banks failed and saw their capital adequacy ratio drop to 13.47% from 14.43%. In the worst-case scenario, assuming GDP growth dropped to 4.15%, some 2% below the latest official GDP print, more than half of China's banks, or 17 out of the 30 major banks failed the test. Needless to say, the implications for a Chinese financial system - whose size is roughly $41 trillion - having over $20 trillion in "problematic" bank assets, would be dire.

Why do we bring this up now? Because according to many Wall Street estimates, as a result of the slowdown resulting from the Coronavirus pandemic, China's economic growth is set to slow sharply, with some banks such as JPMorgan now expecting as little as 1% GDP growth in Q1 assuming the epidemic is contained in the next few weeks; if it isn't, Chinese Q1 GDP growth may print negative for the first time on record.

This is a big problem, because as noted above if the PBOC's 2019 stress test is credible, more than half of China's banks would fail the "stress test" should GDP drop to just 4.15%; and one can only imagine what happens to China's banks if GDP prints negative.

Or, alternatively, one can read the fine print, where we find that among the immediate first order consequences of a GDP crunch is that the bad loan ratio at the nation's 30 biggest banks would rise five-fold, flooding the country with trillions in non-performing loans, and potentially unleashing a tsunami of bank defaults.


Of course, regular readers are wll aware that China's banks are already suffering record loan defaults as the economy last year expanded at the slowest pace in three decades. As extensively covered The slump tore through the nation’s $41 trillion banking system, forcing the not only the first bank seizure in two decades as Baoshang Bank was nationalized , but also bailouts at Bank of Jinzhou, China's Heng Feng Bank, as well as two very troubling bank runs at China's Henan Yichuan Rural Commercial Bank at the start of the month, and then more recently at Yingkou Coastal Bank.

All that may be a walk in the park compared to what is coming next.

"The banking industry is taking a big hit," You Chun, a Shanghai-based analyst at National Institution for Finance & Development told Bloomberg. "The outbreak has already damaged China’s most vibrant small businesses and if it prolongs, many firms will go under and be unable to repay their loans."

While the market is filled with optimistic speculation that the Chinese economy will be spared the worst, we already know that China's top aluminum buyers have already voided contracts with some of the world's biggest copper producers citing "force majeure" provisions. We doubt they will be the only ones, or that China's banks will somehow escape unscathed a millions of businesses freeze their operations, refusing to pay the coupon or debt maturities. This means that China's banks - already undercapitalized from nearly two years of trade war with the US - will bear the brunt of the coming operational and liquidity squeeze, and Beijing will be forced to chose between bailing out hundreds of banks, or letting them fail.

To be sure, JPMorgan is not alone in its dire GDP forecast: UBS estimates growth will slow to 3.8% in the first quarter from a 6% pace at the end of year and to 5.4% for 2020 if the virus is contained within three months. If the virus is more protracted, annual growth could dip below 5%. Goldman Sachs similarly predicts a sharp slowdown in the quarter to 4%, while still predicting full-year growth at 5.5%.

It gets worse.

Doing its own calculations based on China’s stress tests, Bloomberg reports that according to S&P estimates, the worst-case scenario would cause bad debt to balloon by 5.6 trillion yuan ($800 billion), for a ratio of about 6.3%, adding to the already daunting 2.4 trillion yuan of non-performing loans China’s banks are sitting on (a number which, like the details of the viral epidemic, is largely massaged lower and the real number is far higher according to even conservative skeptics).

Predictably, S&P expects that banks with operations concentrated in Hubei province and its capital city of Wuhan, the epicenter and the region worst hit by the virus, will likely see the greatest increase in problem loans. The region had 4.6 trillion yuan of outstanding loans held by 160 local and foreign banks at the end of 2018, with more than half in Wuhan. The five big state banks had 2.6 trillion yuan of exposure in the region, followed by 78 local rural lenders, according to official data.

The problem is that Beijing recently "advised" the largest banks, including Industrial and Commercial Bank of China, to serve their civic duty by bailing out millions of struggling small businesses by providing more cheap loans, rolling over debt and waiving fees, steps which will only add to the total bad debt total.

And so, just as China has scrambled to talk down the impact of the pandemic, so too officials have sought to ease concern over the hit to the banking sector. Zhou Liang, vice chairman of the China Banking and Insurance Regulatory Commission, said on Friday that a potential increase in bad loans is "manageable" without clarifying what level of bad loeans would become unmanageable. Chinese lenders dissolved 3 trillion yuan of bad loans last year alone, he said, adding that bad loan ratio of China’s small businesses was at 3.22%.

Highlighting the plight of small bushiness, most of which are indebted to China's banks, a recent nationwide survey showed that about 30% said they expect to see revenue plunge more than 50% this year because of the virus and 85% said they are unable to maintain operations for more than three months with cash currently available. Perhaps they were exaggerating in hopes of garnering enough sympathy from Beijing for a blanket bailout; or perhaps they were just telling the truth.

In any event, nothing short of a coronavirus cataclysm faces both China's banks and small businesses if the coronavirus isn't contained in the coming weeks.

Until then, banks have no choice but to keep throwing good money after bad, adding to their plight: "Social stability is of utmost importance to the authorities in China," S&P analysts led by Tan Ming said in a recent report. "Therefore, banks have been asked to help carry the burden of this health outbreak."
It gets worse: at a time when banks are desperate for any inbound cash, Beijing is telling them to collect even less interest on existing loans, effectively tying their fate with the success (or failure) of eradicating the coronavirus. As Bloomberg reports, while most state banks agreed to cut the borrowing costs of virus-stricken firms by 0.5 percentage point, the State Council now requires them to ensure that small businesses are paying no more than 1.6% with government subsidy. And even as cheaper financing may help the broader economy, rates below 5% mean banks are barely making enough money to cover their cost of funding after accounting for default risks.

Which brings us to yet another unpleasant comp to the SARS epidemic, or even the 2008 global financial crisis: what differentiates the current episode from 2008 or 2003 "is the lack of bank capital now to support an aggressive bank-led credit stimulus," said Grace Wu, head of Greater China Banks at Fitch Ratings in Hong Kong. "Chinese banks do not have the same capacity to replenish capital now given their profitability has trended down in recent years."

And not even the government in Beijing can magically conjure trillions in new funds to bail out its entire banking system without catastrophic consequences across an economy which is already suffering from the highest inflation in 9 years.

None of this has escaped investors, who are turning more downbeat on Chinese banks by the day, and whose shares have underperformed the benchmark in most of the past five years. The “big four” state-owned lenders, which together control more than $14 trillion of assets, currently trade at an average 0.6 times their forecast book value, near a record low. This also means that in the eyes of the market, as much as $6 trillion in bank assets are currently worthless!

Bank stocks have responded appropriately, with Bloomberg writing that China's credit giant, ICBC with over $4 trillion in assets, is down 11% YTD while China Construction Bank Corp., the nation’s second largest, has lost 7.6% so far in 2020.

The worst is yet to come however, as the unexpected coronavirus epidemic is now their greatest test, and the longer it lasts, the lower the chances of a happy ending: "The resilience of China’s banking system may be severely tested," the S&P analysts said.

Source: zerohedge.com

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