(Non)Performance Anxiety

Despite our expectations of a soft landing in 2010-11, we think the probability of a domestic banking crisis is increasing in China. We now believe there is nearly an even chance that the banking sector will face a solvency crisis in the next five years due to the surge in credit in 2009. As described in a previous RGE Analysis, such an outcome may not result in a liquidity crisis, but it would keep China in a boom-and-bust cycle, defer domestic and global rebalancing and restrain growth. The banking sector’s stock of nonperforming loans (NPLs) declined yet again in Q2 2010, but non-payments on commercial bill financing jumped 10% q/q. Given the strong revenue and profit growth most companies saw in H1, we think this is an important warning sign for the banking sector, and our assumption that NPLs would only increase by RMB1.7 trillion by the end of 2013 may be too optimistic. We are pleased so far with the regulatory zeal to recapitalize China’s banks and take stock of the growing risks on banks’ balance sheets ahead of the coming flood of bad loans—an attitude from which Western regulators might learn a thing or two. Still, the China Banking Regulatory Commission (CBRC) is beginning to look more and more like a little Dutch boy with his finger in the dike.

Read our latest China Monthly for more on banking sector risks.

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