Chinese banks' capital gap to foil economy boost

Inefficient credit could potentially lead to high systemwide divide.

China’s plan to boost its economy may be temporarily thwarted this year by the COVID-led economic shock, but banks’ potential capital shortage has steadied in recent years, reports Fitch Ratings.

Lenders’ inefficient credit could have been as high as 15-22% of total credit as of end-2019, which could lead to a possible systemwide capital gap ranging between $1.35t (CNY9.5t) and $2.78t (CNY19.5t).

Fitch’s scenario analysis does not represent the base case, but suggests that reported systemwide asset quality metrics may underestimate the risk hounding the banking sector.

“The potential capital gap is broadly similar to that at end-2015, when it stood at around 10%-19% of GDP, despite rapid growth in credit since then. This outcome is more positive than the further deterioration we had anticipated when we last conducted such an assessment, in 2016,” analysts said.

In addition, the presence of capital gap still presents a large credit overhang for the banks, but a decline in shadow banking and corporate deleveraging efforts resulted in improved credit efficiency from 2016 to 2019 compared to 2015. However, the improvement will be eroded significantly in 2020 as feeble economic growth and a marginal acceleration in credit will push China's credit efficiency ratio to its lowest level since 2015.

“Fitch expects financial system leverage to reach around 265% of GDP by end-2020. However, as the economy recovers it should stabilise in 2021. Combined with a resumption of official efforts to curb shadow-banking activities and a greater bank focus on lending to retail sectors, this should help to restore credit efficiency,” the report said.