There are signs that point to rising defaults in mortgages, credit cards and other household debt in China, but most analysts are not anticipating a systemic crisis just yet.

More individuals may not be able to service their loans on schedule amid rising unemployment and falling property prices, due to trade tensions with the U.S. in 2019 and the looming global recession brought about by the coronavirus pandemic in 2020. This means the country's rising household loans — a long-term strategy for China to shift the economic growth engine from exports to domestic consumption — could amplify the default risk even while it continues pumping liquidity into the slowing economy.

However, China's largest lenders, some of them so-called systemically important banks, are now more capitalized to withstand shock, analysts noted, compared to where they were during the global financial crisis in 2007 and 2008. Beijing also appears to have a mechanism in place to contain the growing financial risk in smaller banks and microlenders, which are likely being hit harder as they lend more to borrowers with weaker credit profiles.

"We don't think there's a risk of a debt crisis in the short term, but this is just building, building and building in the future," Rory Green, China economist at TS Lombard, told S&P Global Market Intelligence.

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Household debt piling up

As of end-2019, China's household debt to nominal GDP ratio was 55.8%, the highest on record, according to data from the National Bureau of Statistics of China and People's Bank of China. While still lower than many major economies, it was a sharp increase from less than 20% during the global financial crisis.

Meanwhile millions of people have been pushed out of work by the nationwide closure of factories earlier this year, with residents ordered to stay home to contain the COVID-19 outbreak as exports slackened alongside the global economy. China's surveyed urban unemployment rate jumped to 6.2% in February, from 5.3% in January and the monthly average of 5.15% in 2019, according to the statistics bureau.

Home sales in January and February also dropped 35.9% from a year earlier, with the total area sold dipping 39.9% year over year, bureau numbers showed.

About 30% of Chinese households may not be able to service their debt if they have no income for one month, estimated David Wang, head of China economics at Credit Suisse. The debt servicing cost for an average Chinese household is thought to be over 30% of its disposable income, Wang said.

Tommy Xie, head of Greater China research at OCBC Bank, said the key challenge is "demand shock," which could impact the Chinese economy more than February's "supply shock" when factories were forced to shut.

"Talking to some manufacturers in China, some of them may have to reduce working hours or restructure their workforce in May should the situation fail to improve," he said.

Banks getting hit

There are signs of weakening financial health among consumers, based on nonperforming loan ratios of the country's banks in 2019.

Take, for instance, NPL ratios of the credit card and mortgage businesses among China's biggest lenders in 2019, with five of the six largest commercial banks by assets providing these indicators in their annual reports.

Three of them — China Construction Bank Corp., Postal Savings Bank of China Co. Ltd. and Bank of Communications Co. Ltd. — reported a year-over-year increase in credit card delinquency rates of between 0.05 percentage point and 0.86 percentage point. Mortgage delinquency was largely stable in 2019 though: Only Postal Savings Bank reported a 0.02-percentage-point rise in 2019 while three others — Agricultural Bank of China Ltd., Bank of China Ltd. and Bank of Communications — reported a decline of between 0.01 percentage point and 0.03 percentage point. There was no change reported by China Construction Bank.

Industrial & Commercial Bank of China Ltd. did not break down its NPL ratios by loan types for 2019.

Smaller banks however reported a steeper decline in asset quality. Jinshang Bank Co. Ltd., for example, said its NPL ratio of personal consumption loans rose to 6.18% in 2019 from 2.67% in 2018, while Guangzhou Rural Commercial Bank Co. Ltd.'s ratio increased to 1.75% from 0.96%. Bank of Gansu Co. Ltd., reportedly awaiting a state bailout, said its retail loan NPL ratio rose to 4.01% in 2019 from 1.73% the year prior.

"The riskiest part of the population is definitely the low-income households in [less developed] tier 3 and 4 cities [and those who are] working in the private sector, mainly in [small businesses]," said Hang Qian, a partner at Oliver Wyman.

Microlenders were also hit hard. Qudian Inc. said its real-time "D1" delinquency rate jumped to 20% in February, from 10% in the third quarter of 2019. Some have sharply increased their provisions for loan losses. For instance, 360 Finance Inc. increased its provision for loans receivable by more than 10 times to 487.0 million yuan in 2019 from 44.5 million yuan a year earlier.

"Smaller banks are generally more concentrated, closely tied to regional- or even city-level economies. So if you get a sharp downturn, just in one city, then that could be enough to cause a great deal of stress in some of the smaller banks, microlenders and nonbank financial institutions. They're also at a higher risk because their deposits are not growing," Green said.

Size, risk may correlate

The largest lenders are in a stronger position to absorb shocks in economic downturn. The common equity Tier 1 capital ratios of the nation's six largest commercial banks on average rose by 1.68 percentage points between 2013 and 2019, according to S&P Global Market Intelligence.

"The large commercial banks are well capitalized to handle a meaningful increase of household defaults," Wang said.

Green said the contagion risk in small banks and microlenders is likely manageable, too, adding: "We're going to see the [central bank] and larger banks, government-affiliated financial institutions really step into the breach if there is any sign of serious weakness in these small banks."

There were several bank failures in China in 2019 but Beijing either seized management of the lender or launched state bailouts to prevent them from collapsing. This was seen to have helped prevent financial contagion from spreading to other parts of the system.

Qian, though, said this may not be ideal in the long run.

"To some extent, pushing banks to extend credit is the best short-term solution but it could be a longer-term poison as such policy would disallow banks to apply risk differentiation in their day-to-day business," he said.

As of April 14, US$1 was equivalent to 7.05 Chinese yuan.