Jul. 04 2019 — Rapid growth in credit-card debt in China is reminiscent of past expansions elsewhere in Asia. Those episodes ended badly for Hong Kong in 2002, South Korea in 2003, and Taiwan in 2006. The narratives of these cycles are fairly consistent. Financial institutions in search of the next growth driver turned to unsecured consumer lending; competition pushed them to take higher risks, with seemingly good profit during the expansion phase, but substantial credit costs when the cycle turned. S&P Global Ratings believes that some of China's most aggressive credit-players could suffer a similar fate. That said, the country's regulators are aware of history and, in our view, are taking steps to lower system-wide risks.
Credit-card debt, including related cash advances, has risen more than sixfold over six years in China, albeit from a relatively low base. We expect unsecured consumer lending to grow at 20% a year over the next two years, a slight slowdown from 20%+ in the past.
Credit-score and credit-behavior models used by banks have not been fully tested by a consumer downcycle in China. We also anticipate that marginal players and latecomers to unsecured consumer lending are likely to compete aggressively, tapping into risker customer segments. Increasing business partnerships between banks and some types of fintech firms can also multiply asset-quality risk for some banks; in particular, banks with limited experience in unsecured consumer lending and/or inadequate capability in managing risks associated with a rapid increase in such exposures.
In our view, a number of factors mitigate risks to the banking sector from expanding credit-card business. These factors include the current relatively straight-forward, non-complex nature of credit-card lending in China, as well as efforts to enhance credit infrastructure and strengthening regulatory supervision. We also believe major banks are calibrating their risk appetite to manage exposures.
The Boom: Rapid Growth Is Unlikely To Stop Anytime Soon
China's household leverage is likely to keep growing, as policymakers encourage consumption to adjust its economic model. The country's ratio of household loans to GDP stands at around 53%, compared with ratios of 66% in U.S., 72% in Hong Kong, 89% in Taiwan, and 100% in South Korea as of end 2018. China's ratio is lower than most developed markets but higher than some other developing Asian markets, such as India and Indonesia (see chart 1).
The steady growth in household income and favorable employment market over the past two decades could be other factors that have encouraged people to spend their future income using credit (see chart 2).
The biggest consumer borrowing segment is, unsurprisingly, home mortgages. However, unsecured consumer lending has been growing at a breakneck pace in recent years. The banking sector's credit-card and other consumer loans reached Chinese renminbi (RMB) 12.1 trillion (US$1.75 trillion) as of end-2018, or a quarter of the RMB48 trillion in total outstanding household debt as of end-2018 (see charts 3 and 4).
The number of issued credit cards increased to 686 million as end of 2018, from 331 million as of end-2012 (see chart 5), and credit card balances have risen to RMB6.8 trillion from RMB1.1 trillion over the same period (see chart 6).
Consumer loans provide a new growth area for banks, and a broader growth driver for China's economy as the country transition from an industrial-led model. However, such fast growth brings risks, as history shows.
China's Credit-Card Boom Has Unsettling Parallels
We believe inroads made into consumer finance come with risks for China's banks. The growth in China's credit-card market has some similarities with booms in Hong Kong, South Korea, and Taiwan in the 2000s that ended in distress. For example, the impaired asset ratio (nonperforming loans [NPLs] plus the charge-off rate) for Hong Kong's credit-card businesses jumped to 15% at the peak of its crisis. NPLs jumped to above 6% for Taiwan's cash card loans and Korean credit card companies saw NPLs above 11% at the peak, in addition to the more frequent and high level of charge-offs at the time(see chart 7).
Note: Nonperforming loans (NPLs) are defined as loans overdue more than three months. For the U.S., we use S&P Global Ratings' U.S. Credit Card Quality Index (CCQI) over 3-month delinquency ratio and annualized charge-off ratio; For Taiwan & South Korea credit card companies, we use regulators' reported over 3-month delinquency ratios; For China, we use regulator reported credit card NPLs; For Hong Kong, we use regulator's reported over-3month delinquency ratio and annualized charge-off ratio. Source: S&P Credit Card Quality Index, People's Bank of China, China Banking and Insurance Regulatory Commission, CEIC.
Waning corporate loan demand, combined with easy monetary conditions, boosted competitive appetites and led financial institutions to lower their underwriting standards in the past Asian episodes. In addition to generally easier loan standards, market participants often deliberately targeted subprime segments, for their higher potential returns. In Hong Kong, overextended consumers found themselves in a difficult situation when employment condition deteriorated in 2001. In Korea, specialized credit-card service providers dominated the market but regulations prevented them from taking deposits, so they funded the credit expansion by tapping capital markets. The relationship between asset-quality deterioration and funding difficulties caused turmoil.
We find similar features with China today:
Waning corporate loan demand, leading banks to expand their retail loan business. Korea, Taiwan, and Hong Kong financial institutions were keen to find the next growth engine as corporate loans stayed weak after the Asian Financial Crisis. In China today, the government's deleveraging mandate puts a cap on corporate-loan growth. As banks transition to more consumer lending, they increasingly deal with untested borrowers; this includes, for example, fresh graduates or young adults. According to Chinese online credit card manager 51 Credit Card Inc., around half of the China's credit-cardholders are aged between 21 and 30.
Easy monetary conditions. Asian governments implemented policies to spur the economy in the post-crisis years, which led to ample liquidity in their banking systems. Similarly, China has recently been easing conditions to shore up growth amid economic uncertainty.
Fierce market competition encouraging risk taking. In the previous Asian episodes, banks as well as nonbank financial institutions (NBFI) scrapped for market share, leading to declining underwriting standards in the race to onboard customers. In Korea, for example, most card issuers in early 2000s were credit card companies, which weren't as closely regulated as banks. Today in China, the NBFI players are more likely to be fintechs. They generally cannot issue credit cards per se but are providing similar or alternative unsecured consumer products to the market, such as online micro-loans. Similar trends are apparent in China today, with many of the NBFI coming in the form of digital players.
One crucial area to watch: Cash advances and cash loans, which can play a key role in borrowing excess, especially in cases where customers can use one card to repay another. At the peak of the credit-card bubble in Taiwan, banks' cash-card balances made up near half of total card receivables (including credit cards and cash cards) outstanding. Rollovers between credit cards and cash cards led to spiraling debt problems. Although Chinese banks don't issue cash cards, they have increasingly started to conduct cash loan/consumer loan business either separately or bundled together with credit cards. As the yield for this type of products is usually higher, we expect some bank players may tap into this area more deeply, especially after a regulatory clampdown drove out online players who offered similar services on peer-to-peer (P2P) platforms.
China Has Taken Some Steps To Mitigate Risks
Chinese regulators have taken some steps to mitigate risks in its growing consumer-lending market. For example, we expect the People's Bank of China (PBOC) will continue to expand the coverage and scope of its credit-monitoring system. As of May-2019, the PBOC tracks borrower credit data from more than 3,500 banks and NBFIs covering 1 billion personal borrowers and 26 million enterprises. This centralized database could help the sector to manage credit risks better; for example, to prevent borrowers from rolling debt from one lender to another.
China has put a cap on interest rates that can be charged on credit cards: something Taiwan only implemented post-crisis as a remedial step. China's annual cap ranges from 12%-18%, depending on the type of card (in comparison, Hong Kong still has a very flexible pricing regime, with limited restrictions on the interest rates of card loans). Cash loans to consumers have more flexible regulations, with an interest cap at 36% in China. This borrower base is weaker, in our view, given that higher interest rates tend to only attract less prime borrowers. We see this an area that could test banks' underwriting capacity in downturn.
China's credit-card segment is mainly transaction-based (i.e., used to make purchases) with regulated banks being the dominant players. The cash-loan market is also tapped by multiple players other than regulated banks, however tightening regulations and clean-ups after 2017 flushed many "micro-loan" lenders on P2P platforms. The industry peaked at more than RMB1 trillion in loans outstanding in 2017; as of May 2019 there was RMB700 billion in outstanding loans and 914 surviving P2P platforms, down from more than 7,000. As the online micro-lending industry continues to consolidate, some surviving P2P lenders are transforming into loan facilitators that help banks to issue cash loans (i.e., they help banks by channeling customers from their online platform and facilitating risk screening). We believe this promising growth channel could also be a potential route to a fast build-up of household leverage in the system; moreover, it could develop problems as it pushes banks to go beyond their original channels to more aggressively reach potential new clients.
Where Are The Warning Signs And Exposures?
China's joint stock commercial banks (JSCBs), along with some regional banks, are more exposed to consumer lending risks. Credit-card and related cash loans account for about 10% of JSCB's total loans, which is also the case for Bank of Communications Ltd., China's fifth largest bank. This compares with just 3%-4% for the country's four largest banks. JSCBs' rate of issued card growth has been fast in recent years, especially in 2016 and 2017, and we expect this greater exposure will likely continue. We also anticipate some regional banks, as late joiner, will compete aggressively, seeking higher yields and fee income to offset pressure on profits (see chart 8).
Some banks are deepening their exposure by partnering with internet-retail companies to expand their access to high-yield consumer customers. The fintech model appeals in particular to some smaller city commercial banks and rural commercial banks with limited access to Big Data and weaker underwriting capability. While some banks, and many fintechs, have said technology provides superior consumer-lending screening tools than the traditional banking, this claim has yet to be tested by a full consumer credit cycle in China.
In addition to the reliability of data models, the form of bank-fintech partnerships will be key as these collaborations deepen. If the underwriter shares a good portion of the underlying credit risks, then the risks of aggressive practices could be mitigated for banks. If a bank takes a high portion of the risk, however, then such risks could accumulate quickly, as the originators are incentivized to generate business volume--a classic agency problem. Various regulations are being considered or written on this front e.g., to set proportional funding ceilings, and to ban loan facilitation outside the region banks are licensed to operate.
The shift of market dynamics and interlinkages also means partner banks could face risk spillover from the more volatile and emerging fintech sector. If platforms or fintech companies collapse or are wound down by regulators (as occurred in 2017), borrowers cannot roll over consumer loans and default. As the pie gets bigger and institutional boundaries blur, we may see increasing regulatory spillover or arbitrage risks, as well as challenges to implemented regulations.
We believe some smaller banks' consumer lending business models and asset quality might be put to the test over the next 12 months. Overall credit conditions in China will remain under pressure as the economy's growth rate slows. Yet given that consumption is deemed the new GDP engine, we expect consumer lending growth to outpace that in other sectors. Already in the past two years, NPLs have jumped at a few small banks, together with rapid growth in unsecured consumer loans. Asset quality may come under further pressure as China's growth continues to moderate.