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Credit Costs For China's Banks Could Rise By US$224 Billion In 2020

Loan forbearance such as payment holidays, reduced interest charges, and lengthened maturities are an important type of financial support to alleviate the economic fallout wrought by COVID-19. In China, S&P Global Ratings estimates that the additional credit costs due to forborne loans will be nearly Chinese renminbi (RMB) 1.6 trillion (US$224 billion) over 2020. This is equivalent to more than half our pre-outbreak estimate of sector net profits in 2020. The impact to the sector's net profit in 2020 could be less if banks opted to lower their provision buffer.

We expect the sector's nonperforming assets would increase about 2 percentage points to 7.25% after taking the potential impact of forborne loans into consideration. Our forward-looking assessments reflect the impact on bank earnings of the economic damage from COVID-19, including our view of a strong rebound in 2021. However, if virus-related disruptions extend beyond our estimated timeline, then the chances of recouping delayed payments will diminish. Chinese banks would face more pressure to recognize additional credit costs.

Headline NPLs Won't Fully Reflect Soaring Loan Forbearance

We expect forborne loans to be classified as special-mention loans (SMLs) or earmarked within the normal loan basket. Stricter recognition and provisioning is unlikely, because it could weaken banks and stifle their ability to pump fresh funds into the economy.

In our view, the banks will have leeway to avoid classifying forborne loan as nonperforming (NPL) even when the payment relief extends beyond 90 days--which is the cut-off for NPL classification under tighter rules introduced in recent years. Such lenience would in turn relieve banks of hefty provisions. China's regulatory provision requirements at 150% of NPLs is much higher than global averages. But this treatment is designed only for loans to borrowers in good credit standing, and whose businesses were disrupted by the outbreak.

We expect the official reported NPL ratio for the Chinese banking sector to be around 2.2% for 2020, a moderate increase from our estimated 1.74% at end 2019 (including policy banks). Forbearance will be the main explanatory factor while direct fiscal and monetary measures also play an important role (see Appendix 1).

A sharp increase in NPLs and provisions would lift banks' credit costs, pressure profitability, and in turn their internal capital-generating ability and capitalization. It would also hurt borrowers. This is because a nonperforming label on forborne loans would also make it very difficult for a borrower to seek future financing. We believe authorities do not want to see an otherwise performing business fall under such hardship, limiting their potential to rebound after this emergency passes.

Our NPA Calculations Point To More Deterioration

The nonperforming asset (NPA) ratio as defined by S&P Global Ratings will jump to 7.25% in 2020, from a pre-outbreak estimate of 5.23% (see Appendix 2). This calculation assumes that 50% of forborne loans affected by the outbreak are NPAs, in line with our definition.

The Chinese banking sector as a whole could absorb the cost using our estimated pre-provision profit. It could do this, and maintain the overall loan loss provision to NPA ratio at a reasonable level of about 60%.

The Buffers Are There, Should Banks Choose To Use Them

Many Chinese banks have been accumulating substantial provisions, due to the high regulatory requirements. Because of this, they could afford to absorb a hit as large as RMB1.6 trillion, by running down provision coverage (see Appendix 3). We estimate that the loan-loss provision for Chinese banks (including policy banks) was around 200% of NPLs at the end of 2019. This is well above the general 150% requirement. Were the sector to lower the buffer to bring the ratio closer to 150%, this year's profit and loss impact could be a lot more manageable. By doing so, the provision to NPA ratio would fall to around 50%, which is which is slightly on the low side of the reasonable range, in our view.

However, such buffers might not need to be lowered if banks opt to see profits more than halve. Forborne loans affected by COVID-19 are likely to be classified as SMLs, or "earmarked" but classified as normal loans. The provision ratio for these loan classifications are much smaller, but the extent of forborne loans could cut profits by more than half.

If The Crisis Is Prolonged, Credit Costs Would Rise

We believe flexibility on regulatory loan classifications is consistent with International Financial Reporting Standards (IFRS), and that other global banks will also likely employ loan forbearance to soften worldwide recession. IFRS 9 accounting for expected credit losses is not yet a binding constraint, in our view, because lifetime expected credit loss methodology should not be applied mechanically, particularly under the current situation (see IFRS 9 and COVID-19, published by IFRS Foundation on March 27, 2020), and measures to reflect the impact of Covid-19, April 3, 2020 from the Basel Committee on Banking Supervision [BCBS]). The IFRS Foundation and BCBS also encouraged entities to consider guidance from their regulators on the accounting application in the current environment, supporting our view that regulatory considerations are the current binding constraint.

China's listed banks, which have already incorporated IFRS 9 in their reporting, would be under greater scrutiny from investors. Listed banks represent around 70%-80% of the Chinese banking sector's total assets. Unlisted banks have until Jan. 1, 2021 to implement IFRS 9 per the Chinese Ministry of Finance's guidance.

However, with rising risks of a more drawn-out recovery, banks' judgement on loan recovery would be more pessimistic. Accordingly, lifecycle expected credit loss provisions could rise to become the binding constraint. That's particularly if we start to see concessional loan amendments beyond the initial payment holiday, adding pressure to asset quality and credit costs. In our view, the remaining banking sector profits more or less could absorb the deterioration of these forborne loans.

Our base case for China is a gradual U-shaped recovery in the third quarter, leading to a rebound in 2021 GDP. While loan forbearance facilitates financial stability, the credit cost to the banking system could build up over time if the recovery is slower or less than expected. This will in turn restrict banks' ability to lend, straining system liquidity conditions.

S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak about midyear, and we are using this assumption in assessing the economic and credit implications. We believe the measures adopted to contain COVID-19 have pushed the global economy into recession (see our macroeconomic and credit updates here: As the situation evolves, we will update our assumptions and estimates accordingly.

Appendix 1: Policy Measures To Alleviate COVID-19 Effect

As at April 2, 2020, Chinese authorities had approved about RMB1.3 trillion of fiscal measures (see Policy Responses to COVID-19, IMF). The Ministry of Finance approved an additional RMB1.29 trillion of local government special bonds. As of the end of March, RMB1.08 trillion had been issued.

Banking authorities guided for RMB 2.15 trillion worth of lending to virus-battling medical suppliers and the most affected sectors, including micro and small enterprises (MSEs) and private enterprises. This total includes a RMB350 billion special loan quota for policy banks to support MSEs and private enterprises to resume work and production, agricultural and harvesting, and supply chain related business particularly those involved in international trade (see News Conference Notes, from China Banking And Insurance Regulatory Commission, in Chinese only, April 3, 2020).

Market liquidity is boosted by various monetary loosening measures, including a probable deposit rate cut which would be the first in five years. On a regulatory front, the likely slowing pace of the asset management reform gives some additional breathing space to overall corporate financing conditions.

Loan forbearance plays an important role. This includes the payment deferral and other credit support measures for eligible MSEs and households, and higher tolerance for NPLs in Hubei province–-the epicenter of the virus where waivers are more generally applied. We expect loan classifications to soften and we see this as a major form of forbearance, as borrowers won't be stigmatized as defaulters. We also expect this to capture a wider array of borrowers and particularly apply to those otherwise would not have been affected but for the virus.

Appendix 2: The Building Blocks Of Our NPA Estimates

Our 7.25% NPA estimation is the sum of the official NPL ratio and 50% of our estimated forbearance loans that are related to the COVID-19 impact. The discounted conversion ratio takes into account tighter loan classifications under regulatory guidance in recent years. It also recognizes a reasonable forborne loan cure rate among virus-impacted borrowers, in line with our rebounded GDP growth estimation of 8.4% in 2021 (after a fall to 2.9% in 2020). By the same token, our NPA estimate does not incorporate other analytical adjustments into our broader questionable loan definition.

If stricter loan classification were to permanently reverse, we would revise our adjustments accordingly.

Table 1

Our NPA Ratio Composition For 2020
% 2020
NPA ratio 7.25
Reported NPL ratio 2.20
50% of SMLs or earmarked normal loans. 10.10
Note, this does not include "Other special consideration loans" which, in our view, is not aligned with our NPA definition at this stage.

Appendix 3: How We Estimate Credit Costs

Credit costs reflect provisions for credit losses. Our estimate of an additional RMB1.6 trillion of loan-loss provisions takes into consideration rising risks of a more drawn-out recovery. We calculated two scenarios for addition credit costs due to COVID-19: based on whether or not banks maintain high provision buffers, or banks lower them.

If banks maintain high provision coverage buffers:

Credit costs for the banking sector will increase by RMB1.6 trillion. This incorporates a 150% provision cover to the incremental NPLs, a 5% provision cover to incremental SMLs and loans earmarked but kept in the normal classification (without applying the 50% conversion for NPA as defined by S&P Global Ratings). The 5% takes into account rising risks of a more drawn-out recovery. Note, the regulatory target for SML provision cover is 2%.

Sector wide, the NPL cover would remain around 200% (including policy banks). We put the provision cover for NPA at 62%, which is reasonable in our opinion given banks' overall loss experience.

If banks utilize provision coverage buffers to be moderately above regulatory minimums:

We estimate the credit cost to maintain pre-COVID-19 levels. However, the NPL coverage would decrease to around 160% from 200%. The provision cover for NPA is around 50%, which is the low side of the reasonable range.

Irrespective of whether provision buffers are maintained or utilized at a sector level. The hit to individual banks would be largely determined by the bank's credit exposure to highly affected sectors and regions, as well as the size of its loan-loss provision buffer. We expect the impact on the largest Chinese banks to be manageable, while smaller banks with aggressive risk appetite or high geographic concentration in heavily hit regions could see a material squeeze on their asset quality, performance, and capitalization.

Some small to midsized banks that have soft financial strength before the outbreak would face even more pressure. In our view, the government is likely to show a high degree of patience in dealing with these stressed banks to maintain the market confidence in this testing time.

Table 2

Our Key Estimates On Nonperforming Assets And Credit Costs
2019 2020 forecast
Actual Pre-COVID-19 Post-COVID-19, downside Post-COVID-19 base case Post-COVID-19, upside
GDP (%) 6.1 5.7 2.7 2.9 3.2
NPA (bil. RMB) 7,201 8,678 12,522 12,025 11,278
NPA ratio* ( %) 4.78 5.23 7.55 7.25 6.80
If high provision buffers are maintained
Credit cost(bil. RMB) 1,888 2,195 3,823 3,774 3,699
Credit cost (bps) 135 139 241 238 234
If high provision buffers are utilized
Credit cost§ (bil. RMB) 1,888 2,195 2,285 2,245 2,186
Credit cost (bps) 135 139 144 142 138
NPA--Nonperforming assets. *NPA ratio--NPA/gross loans. bps--basis points.

Related Research

  • For Asia-Pacific Banks, COVID-19 Crisis Could Add US$300 Billion To Credit Costs, April 6, 2020
  • Asia-Pacific Credit Conditions Will Be As Bad As In 1997, March 30, 2020
  • COVID-19 Will Stretch CCB's Performance But Fundamentals Are Resilient, March 30, 2020
  • Agricultural Bank of China's Past Provisions To Soften COVID-19 Blow, March 30 2020
  • Industrial and Commercial Bank of China To Stay Resilient Despite COVID-19 Blow, March 27 2020
  • Bank of China Has Adequate Buffers To Withstand COVID-19, March 27 2020
  • Asia-Pacific Recession Guaranteed, March 17, 2020
  • China Banks And Coronavirus: Forbearance Today, Diminished Standards Tomorrow, Feb. 20, 2020
  • Coronavirus In China: Domestic Banks To Face Stress Test, Feb. 3, 2020

This report does not constitute a rating action.

Primary Credit Analyst:Harry Hu, CFA, Hong Kong (852) 2533-3571;
Secondary Contacts:Ryan Tsang, CFA, Hong Kong (852) 2533-3532;
Ming Tan, CFA, Hong Kong + 852 2532 8074;
Research Assistant:Ken Cheung, Hong Kong

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