China’s Big Four dominate world’s top banks

China’s state-owned banks remain among the world’s most profitable and the largest in market capitalization.

According to a report by Boston Consulting Group, China's Big Four all made it to the list of the world's top 10 banks. Industrial and Commercial Bank of China remained the biggest bank in the world while China Construction Bank, Agricultural Bank of China and Bank of China took the third, sixth, seventh positions.

Their continued strength is being driven by a rapid growth in credit spreads, but falling valuation multiples show declining investor confidence in their future profitability.

The Big Four are among the world’s most profitable, with an average of 22% after-tax return on equity (ROE), second only to that in Indonesia where ROE was 26%.

Boston Consulting, however, believes the high profitability of China's banks is likely to be unsustainable as evidenced by falling price-to-book values and price-earnings ratios.

The price-to-book of Chinese banks fell from the record high of nearly five in 2007 to above one. This ratio is a key measure of whether a bank or any public company is undervalued or overvalued.

In contrast, banks in Indonesia, Mexico and India registered a similar ROE-COE (cost of equity) level as China's but enjoyed a much higher price to book ratio.

China's banks' price-earnings ratio also fell from the record high of over 30 to below 10.

A senior executive at Boston Consulting said there clearly is a lack of faith in China's economy, and in the level of hidden losses or likely potential losses.

The company said the single most important thing for Chinese banks to do is to increase transparency and improve loan books to show how loans are actually performing, and what's not. It notes that better transparency will likely increase investor confidence that should lead to higher valuations.

"Without that, there is increasing skepticism that the ROE is likely to fall in the future."