China's banks are in pretty good shape and not vulnerable to a potential financial crisis despite a rapid rise of corporate debt in the country, a U.S. expert said Wednesday.
"While lending more to corporates unable to pay interest and principal on previous loans means financial risks are clearly rising, it is likely that China is years away from a potential banking crisis, providing it with a window to slow the growth of credit to a sustainable level," said Nicholas Lardy, a senior fellow at the Peterson Institute for International Economics.
"A key reason for this judgment is that while the ratio of debt to gross domestic product (GDP) is quite elevated, China also enjoys a high rate of national savings. The level of debt a country can sustain depends significantly on the share of domestic savings in GDP," Lardy, a leading expert on China's economy, wrote in an analysis published on the Financial Times website.
As China's debt build-up is almost entirely in domestic currency and China remains a large net creditor to the rest of the world, the world's second-largest economy is "not vulnerable to a financial crisis such as the one in Asia in 1997", he said.
Lardy noted that banking crises almost always begin with problems on the liability side of bank balance sheets, but Chinese banks' liabilities are overwhelmingly deposits, making potential bank runs less likely.
"In any case, the central bank has substantial tools to deal with potential bank runs. For example, the required reserve ratio imposed on banks is currently 17 percent. This could be cut with hugely positive effects on bank liquidity," he said.
Finally, Chinese banks have far less exposure to poorly performing state-owned enterprises (SOEs) than in the 1990s. Loans to SOEs now only accounted for 30 percent of all renminbi loans of Chinese banks and other financial institutions, down from 62 percent in the mid-1990s, according to the expert.
The International Monetary Fund (IMF) said in April in a report that given China's bank and policy buffers and continued strong growth in the economy, the costs of addressing potential losses on bank lending remain manageable despite the rising corporate debt risks.
To reduce the risks that are accumulating in the financial sector, Lardy urged Chinese authorities to "move aggressively to curtail the flow of credit to chronically unprofitable, mostly state-owned corporates" and close down these so-called "zombie companies," which only survive with aid from the government and banks.
