China's regional banks could face a 2.2 trillion yuan hit in capital losses in the next few years due to debt restructuring at local government finance arms, according to an S&P Global Ratings estimate.
In a worst-case scenario, 74% of the regional banks' lending to local government financing vehicles (LGFV) in China could require debt restructuring, according to a sensitivity analysis the rating agency published Oct. 19. A fifth of regional lenders may need to address a shortfall in capital, it said.
"About one-third of the regional banks' exposures are linked to the lower level governments, districts or counties," Ryan Tsang, managing director of financial institutions rating at Ratings, said during an Oct. 19 conference. "We expect banks to restructure loans and that will cause them to make provisions," Tsang added.
China's central bank in August cut interest rates, and recent media reports suggest the government has asked banks to roll over local government debts with longer-term loans at lower interest rates. Still, the lukewarm housing market — which local authorities heavily rely on because their major funding comes from land sales — remains the main challenge to local governments' financial health and is a threat to lenders that are tied to their own particular regions.
Capital stays adequate
China's regional banks, including city commercial banks and rural commercial banks, primarily run at the local level, as opposed to the much larger megabanks and joint-stock commercial banks that operate nationwide. The regional banking sector accounted for about 30% of commercial bank total assets at the end of 2022, according to Ratings.
"To be clear, we expect China's regional banks as a whole to maintain capital adequacy even in the downside scenario," the report said. Ratings sampled 80 regional banks. As many as 16 would see their Capital Adequacy Ratio fall below the 8% statutory requirement, it said.
Major banks continue to perform much better than their regional peers, Tsang said, adding that the banking system will share some of the pain to resolve the LGFV debt burden even though government will likely offer its support.
Many local governments have limited fiscal resources to support troubled regional banks, and support from the central government — which could put together a program to prevent the situation snowballing into a systemic risk — would likely be the ultimate resort if local governments ran out of reasonable options, according to the Ratings report.
As of Oct. 18, US$1 was equivalent to 7.32 Chinese yuan
