China Debt Headache Swells as Bank Breaches Bad-Loan Buffer

Updated on
  • Bank of China's coverage ratio falls below 150% for first time
  • IMF staff members warn China bad-loan plan may backfire

A slide in Bank of China Ltd.’s bad-loan buffer to below a regulatory minimum added to signs that the authorities could be set to loosen standards for how the country’s banks provision for a growing mountain of nonperforming credit.

“The regulator is probably tolerating such a temporary breach and a cut in the ratio is on the way,” said Hou Wei, a Hong Kong-based analyst at Sanford C. Bernstein & Co. Bank of China might have disclosed a flat or declining first-quarter profit, rather than the 1.7 percent increase it reported Tuesday, if it had maintained its buffer at the approved minimum, he said.

Bank of China breached the requirement for the first time by reporting a 149.1 ratio of provisions to existing nonperforming credit as of the end of March, below the 150 percent requirement set in 2009 by the China Banking Regulatory Commission. No comment was immediately available from a CBRC press officer on Wednesday.

In another sign that the CBRC may loosen requirements, the chairman of China Construction Bank Corp. said on Monday that a reduction in the ratio to about 120 percent to 130 percent would be “reasonable” and “possible.” The regulator “may differentiate among different banks on ratios,” Wang Hongzhang said.

Earnings Season

The earnings season for China’s banks, which will see Industrial & Commercial Bank of China Ltd., Bank of Communications Corp., and Agricultural Bank of China Ltd. report first-quarter profit on Thursday, is underscoring the challenges for policy makers and bankers from a rising tide of nonperforming debt.

China may have $1.3 trillion of loans to borrowers without sufficient income to cover interest payments, with potential losses equivalent to 7 percent of gross domestic product, according to an International Monetary Fund report this month. Additionally, IMF staffers warned on Tuesday that one of the government’s planned initiatives -- letting lenders convert troubled loans into equity stakes in debtor companies -- could leave “zombie” companies afloat and lead to conflicts of interest for bankers.

At Nomura International (HK) Ltd., analyst Sophie Jiang said that the coverage ratio should be cut as a counter-cyclical measure and she was assuming a reduction to about 120 percent when estimating earnings for banks. She wasn’t sure how a breach of the requirement would be viewed by the CBRC.

CBRC’s Tools

The CBRC’s tools for disciplining banks can include suspending new product approvals, cutting loan quotas, or issuing instructions for a coverage ratio to be returned to the regulatory minimum, Hou said.

While the CBRC has warned that banking executives could lose their jobs if they fail to control risks as assessed by indicators including bad-loan coverage ratios, it’s also no secret that officials have been considering easing the 150 percent requirement, in line with banks’ lobbying.

Bank of China’s net income rose 1.7 percent to 46.6 billion yuan ($7.2 billion) in the three months ended March 31 from a year earlier, the lender told Hong Kong’s stock exchange.

After grinding out small profit gains in 2015 -- Bank of China managed an increase of less than 1 percent -- China’s biggest banks may be set to report full-year declines in 2016, according to analysts’ estimates.

Bank of China’s nonperforming loans rose 4 percent from the beginning of the year to 135.8 billion yuan, accounting for 1.43 percent of outstanding credit as of the end of March, the statement showed.

With Chinese banks’ bad loans at an almost 10-year high, the government may let lenders issue securities backed by nonperforming loans.

— With assistance by Jun Luo

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