Aug. 5 (Bloomberg) -- China’s stress tests of banks will assess the risk that a possible slump in property prices may strain developers’ finances and cause homebuyers to default, a person with knowledge of the matter said.
The banking regulator told lenders to include worst-case scenarios of prices dropping 50 percent to 60 percent in cities where they have risen excessively, the person said, declining to be identified because the regulator’s requirement hasn’t been publicly announced. Previous stress tests carried out in the past year assumed home-price declines of as much as 30 percent.
Property stocks fell the most in three weeks in Shanghai today and bank shares also slid as the tougher test assumption signaled the government may be growing more concerned about the health of the real estate market. The China Banking Regulatory Commission reminded lenders that some developers may run out of cash, the person said.
“The stress test highlights the government’s concerns about banks’ exposure to the property market,” said Dai Ming, a fund manager at Shanghai Kingsun Investment Management & Consulting Co. “It’s a pre-emptive measure by the regulator to prevent risks.”
An index tracking property companies traded in Shanghai fell 2.2 percent, the biggest decline since July 13. Bank of Communications Co. fell 2.5 percent and Bank of China Ltd. dropped 1.7 percent.
Banks were also told to stress test loans to industries including steel, cement, construction materials and home appliances that are related to housing, the person said.
Regulators have tightened real-estate lending and cracked down on speculation since mid-April, after residential real estate prices soared 68 percent in the first quarter from a year earlier, according to estimates from Knight Frank LLP, the London-based property adviser.
“They probably think the problems are still out there and setting a more severe worse-case scenario is a way to help the market fully recognize the situation,” said Jinny Yan, a Shanghai-based economist at Standard Chartered Plc. “We certainly can’t say they believe prices will drop by 60 percent, which even we don’t think will happen.”
The CBRC said in a July 20 statement that banks should “continue to deepen” stress tests on lending to property and related industries, citing a speech by Chairman Liu Mingkang during a meeting attended by regulatory officials and bank heads. The release didn’t give details. Officials at CBRC didn’t return calls seeking comment.
Results from previous stress tests show that the ratio of non-performing real estate loans among Chinese banks would rise by 2.2 percentage points if home prices drop 30 percent and interest rates rise by 108 basis points, the person said. Pretax profits would fall 20 percent under that scenario. A basis point is 0.01 percentage point.
Bank of China Ltd.’s bad-loan ratio would climb 1.2 percentage points under the worst-case scenario drawn up in the latest stress tests, Li Lihui, president of the nation’s third-biggest lender by market value, said May 27.
Measures to cool property-price gains included raising minimum mortgage rates and down-payment ratios for second-home purchases, and a suspension of lending for third homes.
Property prices in 70 Chinese cities dropped 0.1 percent in June from the previous month, the statistics bureau said July 12. Prices rose 11.4 percent from a year earlier, the second monthly slowdown after April’s record expansion.
Record lending last year in China and the ensuing surge in home prices have stoked concern that a bubble is forming that may threaten the banking industry. Property stocks are the worst performers on the Shanghai Composite Index this year with an average 23 percent drop, data compiled by Bloomberg show.
China must contain bank lending, keep the yuan’s exchange rate flexible and provide “guidance” for the property market to help ensure “smoother functioning” of the economy, Xia Bin, an adviser to the central bank and director of the Finance Institute at the Development Research Center of the State Council, wrote in a commentary published in today’s China Daily newspaper.
“There is a perception in the real-estate development community that banks and the market cannot tolerate much more than a 25 to 30 percent drop in prices,” said Nicholas Consonery, an Asia specialist at Eurasia Group in Washington.
Still, the government probably doesn’t expect prices to drop by 60 percent, Consonery said in a phone interview. It’s seeking to “signal to the market that banks are sound even with a significant drop in prices,” he said.
China’s property market is beginning a “collapse” that will hit the nation’s banking system, Kenneth Rogoff, a Harvard University professor and former chief economist of the International Monetary Fund, said July 6.
Average prices may fall as much as 20 percent over the next 12 to 18 months, with declines of up to 40 percent in “big bubble” cities, Nomura Holdings Inc. said in a July 2 report. The impact on banks’ asset quality will still be “limited” as long as borrowers have adequate income to keep paying their mortgages, Nomura said.
Central Huijin Investment Co., which owns stakes in China’s largest banks, plans to send more than 190 billion yuan ($28 billion) of bonds in the next few months, the China Daily newspaper reported today, citing unidentified people.
Almost 110 billion yuan will be channeled to state-owned banks to help them replenish capital, the report said.
Regulators testing banks for a 60 percent correction in “only the most bubbly markets” will probably find lenders “will not pose a systemic risk to the banking system,” said Daniel Rosen, principal of the Rhodium Group, a New York-based advisory company.
The banking regulator has reminded lenders that some developers with high debt burdens and large land reserves already face the risk of a funding collapse, the person said. Banks were told to gauge developers’ real borrowing needs by monitoring the progress of projects under construction and to “strictly” control the pace of lending, the person said.
“Special mention” real-estate development loans have climbed in Shanghai since April and rose by 1.4 billion yuan in June, Xinhua News Agency reported Aug. 1, without saying where it got the information.
To contact the Bloomberg News staff for this story: Philip Lagerkranser at email@example.com