Blood From a Stone: The State Council Pressures China’s Beleaguered Banks

China’s State Council is pressuring banks to step up funding for the real economy by forgoing 1.5 trillion yuan in profits. But a sharp hit to profitability would compound banks’ existing challenges in maintaining capital levels, asset quality, and interbank funding. In our annual survey of China’s full-year bank financial results, we highlight the limited options banks have to absorb additional financial pressures:

• Capital. Profits are the only sustainable source of new capital in a banking system as large as China’s (306 trillion yuan or $43.3 trillion in assets) and slowing profit growth will slow credit and asset growth.
• Asset quality. Banks are struggling to manage rising declared and undeclared non-performing assets following pressure to exercise forbearance toward borrowers during the COVID-19 outbreak, which will require additional provisions and capital. There is now a clear trade-off between financial system health and overall credit and asset growth.
• Interbank funding. Banks are still seeing weaker interbank financing conditions after Baoshang Bank’s failure last May. Joint-stock banks have benefited and are seeing stronger asset growth in 2020, but smaller city and rural commercial banks have been squeezed.

In short, the State Council will need to cut banks’ deposit rates to meaningfully reduce borrowing costs for the whole economy, from SOEs to LGFVs to SMEs. But this is only a temporary solution as problems in the financial system intensify. More bank and non-bank failures and restructurings are probable in the near future.