World Economy

Beijing Poised to Bail Out Banks as Bad Debts Climb

The Agricultural Bank of China.The Agricultural Bank of China.

Hit by bad loans, Chinese banks are expected to show a weakening in their capital strength in first-half earnings, raising the prospect that the government might have to inject more than $100 billion to shore them up, according to some analysts.

There are early signs the government is already taking action to help some smaller banks, which are struggling to maintain their capital ratios as China’s economy slows, interest margins fall, and bad debts climb, Reuters reported.

“We believe the recapitalization and bail-out process is already discretely under way. However, it has gone unnoticed as it has started with the smaller, unlisted banks,” said Jason Bedford, sector analyst with UBS.

“We expect this process to accelerate sharply in 2017, particularly among listed joint stock banks,” Bedford said, adding closing the capital shortfall would require an infusion of $172 billion. The largest banks, including Agricultural Bank of China and Bank of Communications, start reporting earnings this week.

Brokerage Daiwa estimates sector-wide profit growth in the first six months of 2016 will remain at just 0.7%. In the April-June quarter, the banking sector’s core capital adequacy ratio, on average, declined by an average 27-28 basis points from the preceding quarter, Daiwa said.

Bedford said in a report earlier in August that fundraising by smaller banks was partly driven by pressure by local governments to maintain credit growth and cushion the economic slowdown.

The banking regulator wants banks to clean up their balance sheets by providing more for doubtful loans and cutting exposure to shadow lending, which for weaker banks could require extra capital or mergers.

While the country’s top five banks had a substantial capital buffer of around 14% at the end of 2015, smaller banks are sailing much closer to the wind, putting the sector’s weighted average Tier 1 capital at 10.69% at end June, down from 10.96% a quarter earlier. That is barely above the 10.5% minimum that the banks in China would need to achieve by 2018.

Roshan Padamadan, equities fund manager with Singapore-based Luminance Global Fund, expects China’s banks will need about $100 billion a year over the next few years, while Wei Hou, senior equity analyst for China banks at research firm Sanford C Bernstein in Hong Kong, estimates they will need $75 billion over the next year.

However, some analysts believe the ratio could be between 15% and 35%, as many banks are slow to recognize problem loans or park them off the balance sheet.