Chinese Banks Lend Now, May Pay Later

By ANDREW BATSON and JASON LEOW A historic increase in China's bank lending this year has helped keep the world's third-largest economy growing during a global recession. Yet there are concerns that this explosion in credit will mean a setback to the progress Chinese banks have made after years of financial reform. China's state-controlled banks have spent the past several years trying to transform themselves into commercial entities for which making loans is a business decision, not a political one. They have overhauled their operations with foreign investors and international expertise. Then the financial crisis hit, and Beijing turned to the banks to help finance its huge stimulus program. The result: In the first four months of 2009, China's banks extended 5.17 trillion yuan ($757.15 billion) of new loans, more than in all of 2008. The banks deny they lowered their standards to meet government demands for more credit. "We have never loosened our risk-control assessment, not even for government-stimulus projects and infrastructure lending," says Wang Zhenning, a spokesman for Industrial & Commercial Bank of China Ltd., the country's largest bank by assets. But the costs of their lending spree are becoming apparent. The push to extend credit so quickly has cut profit margins. Despite banks having 30% more loans paying interest, most banks' earnings are down this year. These loans are also being made while corporate profits are falling sharply. So there are already early signs that more loans are starting to turn bad. "Everyone agrees that China's stimulus lending is damaging future bank balance sheets," says Daniel Rosen, partner at Rhodium Group, a research firm, and visiting fellow at the Peterson Institute for International Economics. The push to support growth now is understandable, but, Mr. Rosen says, "pillaging bank balance sheets is not a strategy for recovery." The question is whether the cost of bad loans in the future is worth the improvement in the economy today. If China's stimulus can get growth back on track, then tax revenues will keep rising and the government should have the resources to bail out banks for any losses. But if the recovery stalls, bad loans could become a bigger burden on future government finances. From 1998 to 2006, the government and private investors spent about 3.8 trillion yuan -- about $475 billion at the time -- recapitalizing China's banks, according to an estimate by Guonan Ma of the Bank of International Settlements. View Full Image Bloomberg News China's government has acknowledged risks from the lending boom but says the boost to the economy is worth it. "In a situation of financial crisis, rapid growth in lending does more good than harm," deputy central bank governor Yi Gang said in a speech last month. He added that "we should also consider the sustainability of the rapid growth of credit and the possible adverse impact." Nonperforming loans now account for about 2% of the total in the Chinese banking system, a relatively low figure. That figure won't rise soon, as analysts believe Chinese banks are now rolling over problem loans rather than calling them in. Indeed, regulators in January specifically instructed banks to support companies that had been affected by the downturn. Yet there are other signs that businesses are having more trouble paying back debts. So-called special-mention loans, those that banks have identified as potentially weak but not officially bad, are starting to increase. The four biggest publicly traded Chinese banks reported a combined increase of 7.69 billion yuan in such loans over the course of 2008, according to their financial statements. That isn't a large sum relative to their total lending, but it is still a sharp reversal from 2007, when those banks reduced special-mention loans by 202.74 billion yuan. Analysts say there isn't enough historical information to predict how much bad loans in China might increase in the current slowdown. The main worry is that pressure from the government might keep banks from properly screening borrowers, causing bad loans to pile up faster. "Credit policy from the government is really driving lending, as opposed to banks' own internal decisions," says Charlene Chu, an analyst at Fitch Ratings in Beijing. The Chinese government is hoping that by pushing banks to lend they can "bring growth back to a robust pace and let all the losses take care of themselves," she says. The banks deny that. Wang Zhaowen, spokesman for Bank of China Ltd., another state-controlled bank, says, "Of course we didn't relax our standards." But the slowing economy is now taking its toll on loans made in earlier years. Mr. Wang says Bank of China recognized about five billion yuan in new bad loans in the first quarter of 2009, compared with about two billion yuan a year earlier, though the bank still cut nonperforming loans overall. "The borrowers are exporters who have suffered during the financing crisis," he says. The increased competition to lend this year has pushed margins down. According to the central bank, the average interest rate on loans fell 0.80 percentage point, to 4.76%, in the first quarter of this year, even though authorities didn't cut benchmark interest rates. The profits of the 14 publicly traded Chinese banks were down 8.9% from a year earlier in the first quarter of 2009, according to Dragonomics, a research firm in Beijing. With profits getting pushed down, banks may be more likely to turn to the government for help with bad loans. Write to Andrew Batson at andrew.batson@wsj.com and Jason Leow at jason.leow@wsj.com