Chinese Banks’ Cash Buffer Thinning as Liquidity Erodes

The weakening of bank asset quality in China is unlikely to fully appear in non-performing loan (NPL) ratios until well into a deterioration, if at all, as the authorities pursue a selective policy of forbearance and support for distressed borrowers, according to Fitch Ratings. Instead, loan delinquencies will manifest themselves first as liquidity stress, as cash inflows from distressed borrowers slow and more resources are directed to support weak entities.

In a special report, Fitch notes that while recent problems in informal lending and among property developers, mall and medium-sized enterprises (SMEs), and local governments have not reached systemic levels, these are not isolated cases of distress, but rather emblematic of excesses from the recent credit boom.

“Forbearance, loan rollovers, transfers of assets off-balance-sheet, and transactions with non-bank financial institutions may be preventing current stress from becoming apparent in NPL ratios, but cash positions clearly show that Chinese banks are under growing strain,” said Charlene Chu, Head of Fitch’s ratings of Chinese banks.

The People’s Bank of China’s (PBOC) recent 50bp cut in deposit reserve requirements, while helping ease liquidity strains on the margins, is too small to have a meaningful impact on credit extension capacity. This capacity has narrowed considerably in 2011 as funding and liquidity have tightened and banks face rising pressure to meet pay-out obligations on wealth management offerings.

Fitch estimates that commercial banks currently have CNY21 trillion in lending and forbearance capacity, which, combined with the CNY16 trillion in deposit reserves at the PBOC, should be sufficient to prevent any major dislocations over the short-term. However, if current rates of erosion continue, it is conceivable that cash constraints in 2012 could become more binding.

“Although at a system level credit capacity remains sizeable, most of these resources are sitting with state-owned banks and the PBOC,” Chu explained. “As a result, some small Chinese banks have dwindling capacity to extend new credit or forbearance, and may require substantial relief in reserve requirements ahead.”


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