COVID-19’s Impacts Will Worsen Banks’ Systemic Risk – Analysis

By Chan Kung and Wei Hongxu*

With Covid-19 becoming the black swan, China’s overall development within the banking industry is still faced with systemic risks. This alone makes the task of preventing financial risk in 2020 hardly possible. 

It needs to be said that the banking industry’s overall performance last year was inseparable from the large-scale capital replenishment, as opposed to the theory of it being closely linked to the improvement of its operating ability. Last year’s situation saw banks attempting to aid capital through various means in order to achieve the scale of expansion and absorb their own non-performing assets.

A set of incomplete statistics shows a total of 8 commercial banks were listed on the Chinese A-stock Market in 2019, raising funds exceeding RMB 65 billion; convertible bonds and additional issuances also amounted to RMB 136 billion and RMB 30 billion respectively; listed banks issued a total of RMB 255 billion in preferred shares; in addition to preferred stocks, the issuance of perpetual bonds was also launched in 2019, with a total of RMB 569.6 billion issued.

When it came to Tier 2 capital, commercial banks issued a total of 72 supplementary capital bonds throughout the year, totaling to RMB 595.5 billion. The overall supplementary capital for commercial banks exceeded RMB 1.6 trillion in 2019. This was largely due to the big state-owned banks and joint-stock banks who possess better qualifications, which increased the gap between different banking industries to a certain extent. With that in mind, the entire banking industry’s ability to improve its performance still falls on the manner in which large-scale expansions are brought about by the capital impulse. 

Though commercial banks performed well overall, the long-term pressure faced by asset quality and market efficiency has not improved significantly. Even without interference from the pandemic, the credit risk in asset shortage and the market’s fund shortage risk will continue building up for the whole year, and Covid-19’s impact may worsen the trend. Concerning banks, most executives believe the narrowing net interest margins and increasing non-performing asset ratios will spread the impact of the epidemic, which will not only bring pressure to the banking industry’s performance, but also cause systemic risks to the entire banking industry if not carefully handled.

In fact, the recent bank run on the Bank of Gansu reflects the fears and worries the country has for the overall banking industry. China International Capital Corporation (CICC) expects banks to accelerate the narrowing of industry interest spreads in 2020, and the rate of non-performing loans will rise y-o-y. Simultaneously, the loans’ growth rates will grow due to the counter-cyclical economic policies.  

Speaking from a macro environment logic, a stagnant economy will inevitably cause problems for business operations, resulting in a large number of defaults that will surely increase the banking industry’s non-performing assets. When it comes to monetary policy, China still hopes to reduce the cost of credit through market-oriented interest rate reform gradually and increase the real economy’s profits. This will lead to the gradual narrowing of future deposit and loan interest spreads, squeezing the bank’s profitability from a macro perspective.

This is even worse for medium and small-sized banks that are already “helpless” as they may not be able to withstand the pressure with poor operations and high asset concentration. During March, Moody’s had changed the ratings outlook to negative for 6 banks, which are the Bank of Nanjing, Bank of Ningbo, Bank of Suzhou, Guangzhou Rural Commercial Bank, Shenzhen Rural Commercial Bank and Fubon Bank (China). Reason being these six banks have large exposure to small and micro enterprises as well as manufacturing industries and thus, are greatly affected by the Covid-19’s spread and the impact from the global supply chain. The CICC has stated that since 2015, banks have been reducing the competing standards. As such, the pandemic has increased their risk exposure, and if unemployment rates continue to rise, the situation will worsen. 

The retail business that the banking business has been relying on in the recent years may encounter prospects of rapidly deteriorating asset quality. In the past, people from China Merchants Bank remarked that many in the banking industry held the perception that the higher the retail percentage, the more diversified the risks will be, though this is not true. China Merchants Banks have done several stress tests but the Covid-19 one. The risks brought by the pandemic to retail finance are all-encompassing and does not discriminate region and industry. The Union Bank of Switzerland (UBS) pointed out that with the rise of personal and corporate default rates, the Bank of China’s total non-performing loans may increase by RMB 5.2 trillion, and profits will experience a jarring 39% decline this year worst case scenario, which is detrimental for the bank’s retail business. 

Bank operations-wise, Covid-19 will have a structural impact on bank credit. Most banks are optimistic about the policy demand for public business, new infrastructure, traditional infrastructure, and medical and health sectors stimulated by policy stimulus. However, these fields are not very profitable despite the traditional advantages they provide to big state-owned banks, and it is difficult for small and medium banks to launch a counterattack.

Meanwhile, the differentiation between industries will accelerate. CICC believes big state-owned banks will bear the responsibility for more counter-cyclical credit policies and lower the credit interest rate to make profits for the real economy. As its credit structure favors large enterprises, infrastructure projects and home mortgage loans, its credit quality will be relatively stable though the profit growth will lag further. At the same time, the profit growth rate of other joint-stock banks and local banks will decline significantly. 

The biggest impact Covid-19 has on banks lies in the asset quality and credit demand. This will heighten the risk of the banking industry’s extensive operation and poor risk identification capabilities. Under a worldwide scale of low interest rates, China’s banking industry will too come under great pressure.

*Founder of Anbound Think Tank in 1993, Chan Kung is now ANBOUND Chief Researcher. Chan Kung is one of China’s renowned experts in information analysis. Most of Chan Kung‘s outstanding academic research activities are in economic information analysis, particularly in the area of public policy.

*Wei Hongxu, graduated from the School of Mathematics of Peking University with a Ph.D. in Economics from the University of Birmingham, UK in 2010 and is a researcher at Anbound Consulting, an independent think tank with headquarters in Beijing. Established in 1993, Anbound