Up to a third of banks may see Tier 1 capital adequacy ratios fall below ideal levels.
Capital positions of the Chinese banking sector’s small and medium-sized institutions are vulnerable to failure should GDP growth slows to 1.6% in 2020 and non-performing loan (NPL) ratio surges to 4.9% for the year, official reports show.
The People’s Bank of China (PBOC)’s latest annual financial stability reports showed that a third or about 10 of the 30 large and medium-sized Chinese banks sampled would fail the regulator’s stress test even under a mild impact stress scenario.
The central bank’s mild impact stress scenario sees China’s real GDP growth slowing to 1.6% in 2020, recovering to 7.8% in 2021 and 5.9% in 2022. Under the test, NPL ratio of the 30 sample banks would also surge to 4.9% in 2020, 5.5% in 2021 and 6.7% in 2022, from 1.5% at end-Q1.
PBOC’s scenario is notedly close to Fitch’s forecast of a 2.7% growth in 2020, 7.7% in 2021 and 5.5% in 2022.
Banks that failed the stress test are those with Tier 1 (T1) capital adequacy ratios (CAR) dropping below 7.5%, T1 CAR falling below 8.5% or total CAR falling below 10.5%.
Tier 1 capital is the core capital of a bank, or the money the bank has stored to keep it functioning through all the risky transactions it performs, such as trading/investing and lending, according to Investopedia.
On the upside, several of the non-failing banks in the stress test would still have capital levels considerably above regulatory minimum requirements.
Under a more severe stress scenario, where the economy contracts by 2.9% in 2020 and expands by 4.5% per annum over 2021-2022, 21 banks would fail the PBoC’s test.
Currently, Fitch does not expect a sharp deterioration in banks’ reported NPL ratios, due to aggressive NPL resolution and continued forbearance. However, this will be at the expense of rising provisioning pressure.
“The authorities are targeting NPL resolution of around $516.41b (CNY3.4t) in 2020, compared with $349.34b (CNY2.3t) in 2019, and we estimate credit costs for Fitch-rated Chinese banks will increase to 1.9% of gross loans in 2020 from 1.4% in 2019,” the report stated.
Meanwhile, the issuance of Additional T1 and T2 capital will help banks to maintain capital ratios above minimum regulatory levels, Fitch added. On the other hand, common equity issuance is made difficult by banks’ below-book market valuations.
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