Banking sector faces bad debt risk

China's banking industry will see consolidation of smaller banks as bad debts tend to rise with economic slowdown, a scholar told a session of the World Economic Forum on Thursday in Tianjin.

The country has failed to implement fundamental reforms including financial reform over the past decade, and currently the banks enjoy very good profits because of their monopoly status, said Zhang Weiying, an economics professor with Peking University.

Yet their good time may come to an end. "Companies will face problems over the next few years and will have difficulty in paying the bank loans," Zhang said, noting that banks' bad debts will rise as a result of default by borrowers.

The banking sector served as the government's major instrument in the stimulus package following the global financial crisis, and the credit boom and lending spree rescued China from falling deep into recession in 2009 and 2010.

The damage to bank's balance sheets is about to surface as China's economy slows down, rating agency Standard & Poor's (S&P) said in a report sent to the Global Times on Wednesday.

"The top banks' credit resilience will be put to test over the next few years, and they will find it tougher to maintain adequate profits as the economy slows and credit losses spiral up," S&P said in the report.

Meanwhile, the government's efforts to push toward financial liberalization could undermine the banks' net interest margins.

"We expect aggressive but unprepared players - particularly smaller banks without a competitive niche - to be hardest hit by the weakening conditions," according to S&P's report.

"You'll see consolidation of smaller banks less vulnerable to failure," Rodney Ward, chairman of global corporate and investment banking with Bank of America Merill Lynch Asia Pacific, told the Global Times on the sidelines of the session.

Yet China's banking industry is more stable than in the Western countries, he said. China's banks have been very careful on overseas acquisitions, and they moderated lending to property and haven't built the bubble the same way as in the US, Ward noted.

China's policymakers also have more flexibility on monetary and fiscal policies compared with the Western partners to stimulate the economy, Ward said.

The US has near zero interest rate, yet China has more than 3 percent interest rate and the central bank can further lower rates in future policy easing.

Also, China has strong fiscal capacity, he said. The US debt-to-GDP ratio is around 90 percent, the ratio is 95 percent in Europe, yet only 17 percent in China or around 40 percent if local provincial government debt is taken into account, which means China has huge scope for policy easing to stimulate the economy.