China's rural commercial banks, with weaker asset quality and bad loan buffers than their larger peers, are facing rising credit risk amid tepid local economic growth.
The China Banking and Insurance Regulatory Commission, or CBIRC, recently urged major bad-debt managers to step up efforts to acquire, manage and dispose of distressed assets from small and medium-sized financial institutions. The regulator's push underscores the weakening credit conditions of rural lenders and concern over potential systemic risk to the banking system.
"With the mandate to support growth, banks will be asked to sacrifice their profitability for the greater good of the economy. And small banks are likely to take a bigger hit with more challenges in asset quality due to their higher exposure to real estate and [small and medium-sized enterprises]," said Gary Ng, senior economist Asia-Pacific at Natixis.
Lenders across China have been heeding Beijing's call to step up lending as the economy has been hit by the pandemic and domestic property market slump. This policy has created more stress on banks serving county-level and rural areas, where economic growth is among the weakest in the country, than on national and urban lenders.
Despite gains in poverty reduction in recent years, economic growth in China's rural areas has been slowed by unsustainable agricultural practices, natural resource degradation and greenhouse gas emissions, the World Bank said March 31. Two-thirds of the rural population have incomes below US$5.50 a day. The Guangxi Zhuang Autonomous Region and Guizhou province, where agriculture accounts for a sizable part of the local economy, are among the poorest areas of mainland China's 31 administrative regions, according to the World Bank.
Rising credit risk
Rural commercial banks in China have the highest exposure to small business loans. They also have the highest nonperforming loan ratios and the lowest buffers against potential bad loans.
Their outstanding balance of loans to small businesses, which the regulator defines as borrowers with a credit line of up to 10 million yuan, totaled 6.397 trillion yuan as of March 31, according to the CBIRC. It was equivalent to 13% of the assets of all rural commercial banks, higher than around 5% for top-tier lenders.
The regulator does not disclose rural banks' exposure to the real estate sector.
Rural banks' aggregate nonperforming loan ratio stood at 3.4% as of the end of the first quarter, compared with between 0.65% and 1.96% for other banks in the same period, according to CBIRC data.
The aggregate provision coverage ratio, which indicates the capital set aside for potential bad loans, was 134% of their gross nonperforming loans as of March 31. The ratio for other banks ranged from 182% to 320% in the same period, according to the regulator.
By the end of 2021, China had 1,651 rural commercial banks, representing 36% of its total number of banks.
At least 23 small and medium-sized banks allegedly underreported an aggregate of 171 billion yuan of nonperforming loans, China's National Audit Office said June 21.
About 10.8% of corporate loans from around 3,700 listed nonfinancial firms in China were at risk of potential default in the first quarter, up from 9.7% in the previous quarter, according to Michael Chang, Hong Kong-based financial service analyst at CGS-CIMB Securities.
State intervention
China's four national bad-loan managers, also called asset management companies, or AMCs, are China Huarong Asset Management Co. Ltd., China Cinda Asset Management Co. Ltd., China Great Wall Asset Management Co. Ltd. and China Orient Asset Management Co. Ltd.
They were created around two decades ago to take over bad loans from the four giant state-owned banks — Industrial & Commercial Bank of China Ltd., China Construction Bank Corp., Agricultural Bank of China Ltd. and Bank of China Ltd.
The CBIRC's push targeting small and midsize banks partly addresses the nonperforming loan problem "by enriching the permitted scope of saleable [nonperforming loans] and enhancing the AMC's participation in cleaning up those nonperforming loans," said Melody Yang, a partner of Simmons & Simmons based in Beijing.
"The regulators are advocating market-oriented means to resolve those issues" rather than solely relying on governmental measures such as writing down the bad loans through inflation, Yang added. AMCs' increased participation "demonstrate their strategic importance in supporting the financial reforms in the banking sector," Yang said.
China Huarong "will actively engage in the reform and risk mitigation of small and midsize financial institutions, strictly abide by relevant laws and regulations, as well as regulatory requirement on state-owned financial capital management, participate in compliance with the law and maintain the stability of the financial market," the bad-debt manager said in an email reply to S&P Global Market Intelligence's enquiry. Three other AMCs did not respond.
As of July 1, US$1 was equivalent to 6.70 Chinese yuan.