China Growth Enough to Avert Prolonged Bank Crisis, S&P Says

Steady growth in China should help avert a drawn-out crisis in its banking sector by aiding industrial consolidation and economic rebalancing, according to Standard & Poor’s.

“A prolonged crisis is unlikely,” analysts Naoko Nemoto and Liao Qiang wrote in a report dated yesterday and released today. “Growth should support the government and help the industrial sectors to resolve the problems relating to excess capacity over time. And that in turn should limit the systemic risk for Chinese banks.”

Economic expansion will hold at about 7 percent until at least 2016, the ratings company wrote. That would be more than any other Asian country during the next two years, according to forecasts compiled by Bloomberg. Decelerating corporate indebtedness, high profitability and core capital at the banks, and signs the government will step in both to curb excess credit growth and with capital injections if needed will also help the nation’s financial institutions absorb any losses, S&P said in the report.

China is struggling to bolster expansion in the world’s second-largest economy as manufacturing and exports slow. The nation unveiled steps to support growth last week after factory output contracted a third month in March, according to an HSBC Holdings Plc and Markit Economics gauge, and overseas shipments fell the most since 2009 in February. Lenders face deteriorating loan quality and fallout from sales of now-troubled wealth management products.

Japan’s Lesson

Chinese banks will probably avoid a repeat of the sort of financial crisis that Japan faced in the 1990’s, S&P said. While Japan’s “sluggish response” to the crisis contributed to economic stagnation during that decade, “China appears to have taken note from Japan’s past troubles,” and is likely to take timely government measures that aid lenders, it said.

Investors in a 3 billion yuan ($483 million) trust product linked to a collapsed miner and distributed by Industrial & Commercial Bank of China Ltd. narrowly avoided losing their money in January, when the notes were bailed out days before their scheduled maturity.

“Certain parts of the shadow banking sector, notably trust companies, will continue to be the weak link in China’s financial system,” Tokyo-based Nemoto and Beijing-based Liao wrote. “Even if banks choose not to bail out distressed products, they aren’t insulated from contagion risk or collateral damage stemming from credit failures in the shadow banking system.”

Financial Distress

S&P doesn’t rule out financial distress and severe losses during the next two to three years, according to the report, which cited high exposure to loss-making companies and any correction in the property market as risks.

Corporate debt climbed to 102.8 percent of gross domestic product last year, S&P wrote. The nation’s combined household and company indebtedness remains lower as a proportion of the economy than in the U.S. and Spain.

Servicing that debt is becoming more expensive. Top-rated Chinese companies pay an average 6.15 percent to borrow onshore after touching an all-time high of 6.43 percent on Jan. 14, according to Chinabond indexes. The seven-day repurchase rate, a gauge of funding availability in the interbank market, has averaged 4.04 percent this year, 81 basis points more than in the same period in 2013.

“The loan quality of Chinese banks is likely to deteriorate,” S&P wrote in its report. “A significant correction in the property market would also bite, given the banks’ exposure to the debt-laden financing companies of local governments and highly leveraged property developers.”

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