China's Banking Sector Headed For Crisis

MSN Money May 1, 2012

4/30/2012 7:57 PM ET

By Jim Jubak

The only way to avoid a financial crisis in China is for that government to kick-start growth. And that would be good for China's banks and for investors -- for a while.

What country does this describe?

The country's banks are short of capital and will have to go to the financial markets to raise more this year -- and in 2013.

Bank balance sheets have ballooned as a result of lending to real-estate developers.

Everyone believes that banks' official accounts seriously understate the number of bad loans on their books.

And, finally, it's just about impossible in this country to separate bank and government finances.

Spain or Italy? Of course. And you can work your way around Europe adding other names to the same list of guesses.

But the country I had in mind was China.

An economic bubble in China?

China's banking problem isn't as far along as those in Europe. Notice that I'm calling it a "problem" rather than a "crisis." But China's banking sector is headed toward a crisis -- and the government's efforts to head off that escalation will be a major driver in China's economic and monetary policy this year and next.

Want to understand how much stimulus Beijing will pour on its economy -- and therefore whether you should be putting money into Chinese stocks or taking it out (and when)? Take a long look at China's banks.

Jim Jubak

If you understand the nature of China's banking problem, you'll understand why I believe that China's government will move sooner rather than later, and more aggressively rather than more moderately, to stimulate China's economy. In the short run, China simply can't afford to let a slowing economy make the problems in its banking sector worse. In the long run? Ah, that's a very different question with a much more worrisome answer.

Let's start with the strangest manifestation of the problems in the sector: the need of China's banks to raise huge amounts of capital. In the past 12 months, according to Citigroup (C), China's seven biggest banks have raised a combined $52 billion in capital. Citigroup estimates that the banks are looking to raise an additional $18 billion in capital in the next few months.

To put that in the context of the euro debt crisis, the $70 billion in capital raised or projected to be raised by China's biggest banks compares with the $84 billion that the Irish government needed to recapitalize its banks and the projected $130 billion to $160 billion that Bank Paribas recently estimated might be needed to recapitalize Spanish banks.

China isn't yet in as deep water -- especially when you remember that China's economy is, at $11.3 trillion (at purchasing power parity, not the official exchange rate), about eight times the size of the $1.4 trillion Spanish economy.

But $70 billion isn't a trivial amount of capital to raise, and the need by China's banks to raise this much so quickly is startling. After all, China's Prime Minister Wen Jiabao recently criticized China's banks for making too much money. In 2011, China's four biggest banks reported a combined profit of more than $90 billion, a 25% increase from 2010. Agricultural Bank of China (ACGBY), the least profitable of the big four lenders, made $18.9 billion in 2011. That's almost as much as JPMorgan Chase (JPM), the most profitable U.S. bank, made that year.

So why do China's banks need to raise so much capital -- and how could they possibly be in trouble?

Following the money

First of all, these tremendously profitable banks can't use retained profits from their lending activity to build up capital against those loans. The banks don't retain all of the profits but instead pay out a high percentage in dividends. In 2010, for example, when profits at the big four banks equaled about 500 billion yuan (roughly $79 billion), the banks paid out 144 billion yuan -- 29% -- in dividends. Much of that went to the banks' biggest shareholder, the Chinese government.

In the same year that the banks paid out 144 billion yuan in dividends, they also raised 199 billion yuan in capital on the financial markets.

In other words, China's banks currently operate as a huge cash-transfer machine. China's banks make profits lending at a large interest rate spread -- an average 2.7 percentage points currently -- because the People's Bank of China has set a floor under what banks can charge on loans and put a ceiling on what they can pay depositors. (The current 3.5% cap on interest on one-year deposits is running slightly below the most recent 3.6% rate of inflation.)

Much of that profit is recycled to Beijing, which in turn makes sure that the banks can raise capital in the financial markets by gently pressuring global institutions to buy into the bank offerings (with the understanding that doing business in China might be easier for institutions that participate) and by having state-owned companies step up to buy into the offering as well.

For the big banks, however, the system is starting to show some stress, because the balance sheets of these banks have been growing so rapidly. In March, China's four biggest banks reported that total loans and other assets had climbed 14% in the first quarter to $7.4 trillion. That's roughly the size of the German, French and United Kingdom economies combined.

Some of that balance-sheet increase results from the banks' role in financing China's $588 billion stimulus to combat the effect of the global financial crisis. Some comes from the sector's participation in the country's real-estate boom. And some of it is more recent as banks, in response to government worries about an economic slowdown, have again increased lending. New bank lending from the country's big banks came to $160 billion in March, 21% higher than the consensus estimate of economists surveyed by Bloomberg.

And all those loans increasingly worry regulators. What if they start to go bad?

Continued on the next page. Stocks mentioned include Bank of China (BACHY) and China Construction Bank (CICHY).

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banks making a profit for doing bussiness OMG what is happening, oh wait, isn't that why they are in business????????????????????????????

I know us Repubs are so unfair to want a business to be able to supply jobs, products, and tax money to the states, and be able to make a profit, we suck don't we, you piece of work, oh ya, sorry for saying the work word.

Guess the oil companies making record profits because we gave them record sales is totaly out of the question too. Russia can be found by rowing your boat west of Seattle, just keep rowing.

2 3ReportSpamusual suspects5 hours ago

What if the sky fell? That's a bigger worry.

clownfeet: thanks for a glimpse into the future.

1 1ReportSpamTR Rose (Ralph Johnson)7 hours agoDon't listen to this crap! Put your money into GOLD, nothing else or the corrupt Republican corporates, their Wall Streeters & political puppet will steal your money! Let China crash, the sooner the better for them & the U.S.! We're next, look out 2013!! Bring it on and get it done! You can thank your corrupt Republican OIL & FINANCIAL corporates for the economic collapse! And ALL FOR CAPITALISTIC GREED!Vote STRAIGHT DEMOCRATIC, the lives you save WILL be YOURS & your CHILDREN, not just the CHILDREN of the 1%!!! 3 12ReportSpamclownfeet14 hours ago

This economic problem we are facing in the country is everyones problem it does not matter how much anyone has!

Why not pass a bill that requires everyone to pay cash money on the deficit?

work out a plan to eliminate the deficit, on a sliding scale some can pay 100.00 dollars others can pay a thousand, up to a million dollars, then have all corporations, all businesses, banks organizations etc. pay a certain amount of cash, leave the tax base low for another couple of years as the economy grows, give all corporations, banks etc. a tax break for the cash money they pay over ten years, if possible raise enough to bring the debt down by even six trillion dollars this year, dont cut government spending for another year or two but look for ways to save, without throwing the recovery off!

why kick the can down the road any longer?

3 6ReportSpamclownfeet16 hours agoThe banks in this country are in the best position to double their profits this year than ever be for, all through this recession they have been building up strenth to be able to make the most profits in the recovery than anyone else, the stock prices are a bargain now when they start to go up they may not come down for a very long time buying bank stocks would be a good vehicle for anyone's retirement, or to help finance children's education if they buy and hold them for ten years or more it is almost a sure thing! 4 11ReportSpamAdd a commentReportPlease help us to maintain a healthy and vibrant community by reporting any illegal or inappropriate behavior. If you believe a message violates theCode of Conductplease use this form to notify the moderators. They will investigate your report and take appropriate action. If necessary, they report all illegal activity to the proper authorities.CategoriesSpamChild pornography or exploitationProfanity, vulgarity or obscenityCopyright infringementHarassment or threatThreats of suicideOtherAdditional comments(optional) 100 character limitAre you sure you want to delete this comment?/**/ DATA PROVIDERS

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So why do China's banks need to raise so much capital -- and how could they possibly be in trouble?

In the same year that the banks paid out 144 billion yuan in dividends, they also raised 199 billion yuan in capital on the financial markets.

And all those loans increasingly worry regulators. What if they start to go bad?

Continued on the next page. Stocks mentioned include Bank of China (BACHY) and China Construction Bank (CICHY).

China's Banking Sector Headed For Crisis

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