Rapid loan growth puts Chinese banks at risk

Loan growth among Chinese banks hit more than Rmb7.76 trillion ($1.13 trillion) in the first half of 2009, a record high. As a result, asset quality is likely to slip further in 2009, but should remain highly manageable. It could deteriorate sharply in the next two to three years, however, if the economic slowdown is protracted in China.

Chinese banks seem to be lending so aggressively despite the economic slowdown for three key reasons. First, the strong growth suggests that the banks' corporate governance is still relatively weak and that the government continues to exert strong influence over banking practices as a dominant shareholder. Second, the banks appear willing to extend additional funding to borrowers facing cash-flow difficulties on the premise that such difficulties are short-term in nature and should correct themselves when China's growth recovers. And third, they may be looking to compensate for the negative effects on earnings from the squeeze in net interest margins.

We expect the quality of new loans to be on average inferior to the banks' loan book a year ago. That's because the banks are either expanding into an enlarged but inferior client base or making incremental loans to existing clients with deteriorated financial metrics. Some new borrowers had no or limited access to bank credit in the past because they didn't meet previous underwriting standards. But banks are likely to have eased their underwriting standards for projects related to the government's stimulus package, as the government relaxed the capital leverage requirement for many types of projects. Loan quality should, however, be adequate for infrastructure projects that the central government or affluent provincial governments have backed; but these loans perhaps represent only a fraction of total new lending.