Index > Briefing
Thursday, April 16, 2020
Covid-19 Makes Banking Systemic Risk to Worsen

The spread of Covid-19 has not only resulted in turbulent financial markets, but also a worldwide economic crisis. This makes the environment that China's financial industry is facing even more severe. Based on the listed banks' situation as shared by themselves, it looks like commercial banks are generally seeing an improvement in their performances and operations as of 2019. As stated by fellow regulators, the overall asset quality in banking systems has improved, and the size of asset and profits has increased. However, it must be stressed that the banking industry's long-term problems have yet to improve. With Covid-19 becoming the black swan, China's overall development within the banking industry is still faced with systemic risks. This alone makes the task of preventing financial risk in 2020 hardly possible.

The current performance from 36 listed banks shows the banks are greatly divided. When it came to revenue, Caixin's publication discovered joint-stock banks are faring better compared to big state-owned banks whilst urban commercial banks performed better than rural commercial banks. The 6 state-owned big banks' average revenue increased by 7.78% in 2019, down 1% y-oy; the shares of the 6 stock banks are 15.85%, a 4% increase y-o-y; 18.6% for 17 urban commercial banks, 2% increase y-o-y; and 8.36% for 6 rural commercial banks, 9% decrease y-o-y. According to China Banking and Insurance Regulatory Commission's February report, China's domestic and foreign currency assets in its financial institutions were worth RMB 290.0 trillion, an increase of 8.1% y-o-y. Moving on to profits, commercial banks accumulatively realized net profits worth RMB 2.0 trillion in 2019, approximately 6.2% y-o-y, a 1.48% increase over the same period back in 2018. In terms of asset quality and its ability to resist risks, the banks' bad loan ratio remained stable throughout 2019 while its capital adequacy ratio experienced a rebound. Overall, the data quoted above proves that it is difficult for the banking industry to maintain performance growth despite a decrease in economic growth and an increase in corporate credit risk back in 2019.

It needs to be said that the banking industry's overall performance last year was inseparable from the large-scale capital replenishment, as opposed to the theory of it being closely linked to the improvement of its operating ability. Last year's situation saw banks attempting to aid capital through various means in order to achieve the scale of expansion and absorb their own non-performing assets. A set of incomplete statistics shows a total of 8 commercial banks were listed on the Chinese A-stock Market in 2019, raising funds exceeding RMB 65 billion; convertible bonds and additional issuances also amounted to RMB 136 billion and RMB 30 billion respectively; listed banks issued a total of RMB 255 billion in preferred shares; in addition to preferred stocks, the issuance of perpetual bonds was also launched in 2019, with a total of RMB 569.6 billion issued. When it came to Tier 2 capital, commercial banks issued a total of 72 supplementary capital bonds throughout the year, totaling to RMB 595.5 billion. The overall supplementary capital for commercial banks exceeded RMB 1.6 trillion in 2019. This was largely due to the big state-owned banks and joint-stock banks who possess better qualifications, which increased the gap between different banking industries to a certain extent. With that in mind, the entire banking industry's ability to improve its performance still falls on the manner in which large-scale expansions are brought about by the capital impulse.

Though commercial banks performed well overall, the long-term pressure faced by asset quality and market efficiency has not improved significantly. Even without interference from the pandemic, the credit risk in asset shortage and the market's fund shortage risk will continue building up for the whole year, and Covid-19's impact may worsen the trend. Concerning banks, most executives believe the narrowing net interest margins and increasing non-performing asset ratios will spread the impact of the epidemic, which will not only bring pressure to the banking industry's performance, but also cause systemic risks to the entire banking industry if not carefully handled. In fact, the recent bank run on the Bank of Gansu reflects the fears and worries the country has for the overall banking industry. China International Capital Corporation (CICC) expects banks to accelerate the narrowing of industry interest spreads in 2020, and the rate of non-performing loans will rise y-o-y. Simultaneously, the loans' growth rates will grow due to the counter-cyclical economic policies.

Speaking from a macro environment logic, a stagnant economy will inevitably cause problems for business operations, resulting in a large number of defaults that will surely increase the banking industry's non-performing assets. When it comes to monetary policy, China still hopes to reduce the cost of credit through market-oriented interest rate reform gradually and increase the real economy's profits. This will lead to the gradual narrowing of future deposit and loan interest spreads, squeezing the bank's profitability from a macro perspective. This is even worse for medium and small-sized banks that are already "helpless" as they may not be able to withstand the pressure with poor operations and high asset concentration. During March, Moody's had changed the ratings outlook to negative for 6 banks, which are the Bank of Nanjing, Bank of Ningbo, Bank of Suzhou, Guangzhou Rural Commercial Bank, Shenzhen Rural Commercial Bank and Fubon Bank (China). Reason being these six banks have large exposure to small and micro enterprises as well as manufacturing industries and thus, are greatly affected by the Covid-19's spread and the impact from the global supply chain. The CICC has stated that since 2015, banks have been reducing the competing standards. As such, the pandemic has increased their risk exposure, and if unemployment rates continue to rise, the situation will worsen.

The retail business that the banking business has been relying on in the recent years may encounter prospects of rapidly deteriorating asset quality. In the past, people from China Merchants Bank remarked that many in the banking industry held the perception that the higher the retail percentage, the more diversified the risks will be, though this is not true. China Merchants Banks have done several stress tests but the Covid-19 one. The risks brought by the epidemic to retail finance are all-encompassing and does not discriminate region and industry. Bloomberg previously reported two Chinese banking executives shared the credit card debts that were overdue in February surged about 50% from the same period last year. China Merchants Bank President Huiyu Tian once said that the most direct and largest impact the epidemic has on the bank is its quality of assets. In February, the overdue rate of credit cards, mortgages, and small and micro businesses increased substantially y-o-y. The Union Bank of Switzerland (UBS) pointed out that with the rise of personal and corporate default rates, the Bank of China's total non-performing loans may increase by RMB 5.2 trillion, and profits will experience a jarring 39% decline this year worst case scenario, which is detrimental for the bank's retail business.

Bank operations-wise, Covid-19 will have a structural impact on bank credit. Most banks are optimistic about the policy demand for public business, new infrastructure, traditional infrastructure, and medical and health sectors stimulated by policy stimulus. However, these fields are not very profitable despite the traditional advantages they provide to big state-owned banks, and it is difficult for small and medium banks to launch a counterattack. Meanwhile, the differentiation between industries will accelerate. CICC believes big state-owned banks will bear the responsibility for more counter-cyclical credit policies and lower the credit interest rate to make profits for the real economy. As its credit structure favors large enterprises, infrastructure projects and home mortgage loans, its credit quality will be relatively stable though the profit growth will lag further. At the same time, the profit growth rate of other joint-stock banks and local banks will decline significantly.

The biggest impact Covid-19 has on banks lies in the asset quality and credit demand. This will heighten the risk of the banking industry's extensive operation and poor risk identification capabilities. Under a worldwide scale of low interest rates, China's banking industry will too come under great pressure.

Final analysis conclusion:

While the banking industry's overall performance was solid last year, it is expected to encounter more challenges due to its reliance on large-scale operations long-term as a result of Covid-19's impact. Additionally, some long-term problems will be further exposed due to the epidemic, which may lead various risks to breaking out. Put simply, this year's goal to prevent financial risks will prove to be more a challenge than ever.

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