Bad loans threaten China’s recovery

A tsunami of bad loans could sink many Chinese banks.

China's banks have been building up resources against a rising tide of bad loans, underscoring the potential risk to its financial system. Despite reporting double-digit profit growth for the third quarter and flat or declining nonperforming loans, China’s Big Four state-owned banks are increasing their provisions against nonperforming loans for the third consecutive quarter.

Agricultural Bank of China Ltd. raised its provisions to 311.2% of nonperforming loans, up 48.10 percentage points from 2011 while China Construction Bank Corporation raised its provisions by 21.48 percentage points to 262.9%.

International and Commercial Bank of China, the nation’s largest bank, said that its provisions are 288.33% of nonperforming loans, up 21.44 percentage points from 2011. Bank of Communications said its provisions were 263.26% of nonperforming loans, up 6.89 percentage points from 2011.

Ironically, this build-up comes at a time when Chinese banks' profit growth has been exceptionally high. Banks profits, however, are also under pressure as China continues liberalizing interest rates. This liberalization will erode net interest margins, or the spread between interest rates charged for loans and paid on deposits, that is the major source of profits for Chinese banks.

As a result, bank profit growth will sink slower in 2013, according to some analysts. Earnings are expected to plunge into the low single digits while some banks will see no growth at all.