Banks' asset quality 'faces pressure'

Bad loan ratio rises, but risks still 'under control', PwC report shows

China's top 10 listed banks face downward pressure on asset quality in the current half-year, but the risks are under control, according to a report by PricewaterhouseCoopers International Ltd released on Tuesday.

PwC analyzed the first-half asset quality of the four major State-owned commercial banks and six joint-stock ones to develop its forecast for the second half.

The 10 banks' total non-performing loans stood at 411.7 billion yuan ($67.3 billion) at the end of June, up 9.43 percent from the beginning of the year. The average NPL ratio was 0.95 percent, up 0.02 of a percentage point.

The increase in bad assets was mainly caused by a slowing economy and widespread industrial overcapacity, said Raymond Yung, financial services chief with PwC China.

The absolute amount of NPLs, as well as the ratio, may continue to rise through year-end, presenting more risks in asset quality management, Yung added.

The top 10 listed banks generated total interest income of 1.77 trillion yuan as of late June, up a mere 6.57 percent year-on-year. The year-earlier growth rate was 33.72 percent.

The slowdown was attributable to two rounds of interest-rate cuts by the central bank this year, said the report.

Returns on interest-bearing assets declined at eight of the 10 banks because of lower loan yields, compared with the same period in 2012.

The deregulation of interest rates will further encroach upon banks' profitability, prompting them to expand their scope of business.

PwC suggested that wealth management products, if properly regulated, could generate much alternative income.

"WMPs amounted to 9.1 trillion yuan by the end of June, having grown continuously since 2011," said Richard Zhu, partner of banking and capital markets at PwC China.

These products "have great potential for innovation to create distinctive advantages for the banks, even though they do not generate equally high returns as the net interest margin."

Many of the banks are innovating with WMPs to cope with interest-rate liberalization, said the report.

"The liberalization of interest rates demands a higher level of bank competence in asset, liability and interest-risk management," said Jimmy Leung, banking and capital markets chief for PwC China.

"Banks also need to improve their pricing capabilities and optimize their risk management competence to prepare for the eventual deposit-rate liberalization."

The China Banking Regulatory Commission introduced stricter rules for evaluating credit assets' quality in January. Capital adequacy ratios calculated using this new system were 0.5 to 1 percentage point lower than those computed using the previous method, according to PwC.

"The new regulation has pressured banks to seek additional capital," said Yung. "In the latter half, it is crucial for banks to taper capital consumption and explore supplementary capital instruments."

In spite of the risks, PwC believes that the asset quality and profitability of Chinese banks are relatively healthy. Further financial reform will require more effective resource allocation and risk diversification, which may also benefit the entire economy.

Zhuang Jian, an economist with the Asian Development Bank, said that there won't be any "damaging risks" so long as innovations are carried out within the scope of supervision.

"However, joint-stock lenders may face even larger pressure as their customers, mostly smaller enterprises, are more volatile in times of change than large State-owned" enterprises, Zhu warned.