At least two-thirds of listed Chinese banks are returning more of their 2019 earnings to shareholders, a move that pleases investors but raises questions from analysts concerned about the lenders' draining of capital buffers amid the economic slowdown.

Among the 45 listed Chinese banks that disclosed dividend information for both 2018 and 2019, 30 increased their 2019 payout ratios by an average of 698 basis points from a year earlier, according to data from S&P Global Market Intelligence.

While the 30 lenders declared a total of 265.90 billion yuan in dividend payments for 2019, eight of them reported weaker capital strength for the period. Seven of these are small and midsize lenders with less than 3 trillion yuan in total assets at 2019-end. The common equity Tier 1 capital ratios of those eight banks were also down by an average of 39 basis points in 2019 from a year earlier, the data showed.

"It's not financially prudent," Alicia Garcia-Herrero, chief APAC economist at Natixis, told S&P Global Market Intelligence. "The capital buffer is much smaller outside of the five largest [banks]."

Regulators in developed jurisdictions such as the U.K. and Australia have urged banks to suspend or reduce dividends to conserve capital, so as to step up lending while writing off even more bad loans to help reboot their virus-hit economies. China, which reported the world's first COVID-19 infections in late 2019, faces the same set of challenges though regulators there have not publicly commented on the dividend policies of banks.

However, analysts said that with China's economy contracting for the first time on record in the first quarter and other major economies reporting recession, most Chinese banks are unlikely to remain as generous to shareholders in 2020.

"Banks are asked to support the economy during these uncertain times, fueling an increasing need for capital build," said Harry Hu, an analyst at S&P Global Ratings.

Smaller banks may lower dividends

Cindy Wang, a China banking analyst at DBS Bank, said smaller banks are more likely to reduce 2020 payout ratios than larger ones.

"The potential risk for [Chinese] banks to lower dividend payout or not pay dividend is if asset quality deteriorates and that they need to reserve more capital in the book," she said.

In the first quarter, city commercial banks, privately owned banks and rural commercial banks reported the highest year-over-year increases in nonperforming loan ratio among all bank types, according to the latest data released by the China Banking and Insurance Regulatory Commission.

Most banks in China remain reluctant to heed Beijing's call to lend more aggressively to small businesses and rural borrowers as the economy shrank. Locally focused, smaller and less capitalized banks are hence seen as more vulnerable, as they lend mostly to such customers that often carry weak credit profiles while needing the money most.

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"For smaller banks, in general, we see higher [net interest margin] and asset quality pressures. This could in turn add pressure to capitalization, and reducing dividends is one way to alleviate this," Hu said. "Increasing payout would be counterproductive in this context."

Hu and Garcia-Herrero believe smaller banks will need to raise fresh shareholder capital in 2020, probably by issuing perpetual bonds. As most Chinese banks are still trading below book values with domestic government bond yields remaining persistently low, undated bonds will remain an attractive fundraising option for Tier 1 capital in 2020 compared to issuing preference shares, analysts have said.

Room at the top

Unlike smaller lenders, the nation's largest state-owned commercial banks are more likely to keep dividend payout ratios at around 30%, as in recent years, Wang said. This is due mostly to better asset quality, since they lend mainly to other state-owned companies and large corporates that are typically better placed financially to weather an economic slowdown.

In the first quarter, the nonperforming loan ratios of large commercial banks and joint stock commercial banks came to 1.39% and 1.64%, respectively, which were lower than the sector average of 1.91%, according to the CBIRC.

For the four largest banks, their 2019-end common equity Tier 1 ratios were well above regulatory minimum of 10%, which will give them more buffer to set aside more of their earnings to return to shareholders, Wang added.

As of May 19, US$1 was equivalent to 7.10 Chinese yuan.