UPDATE 1-China banks' bad loan ratio hits two-year high

Thu Feb 13, 2014 5:47am EST

* NPL ratio rises to highest point since end-2011

* Capital adequacy ratio also rises

* Bank asset quality to deteriorate further in 2014

* Loans to local govts and overcapacity sectors in focus

SHANGHAI/BEIJING, Feb 13 (Reuters) - Chinese banks' non-performing loan ratio rose to its highest level in two years in the last three months of 2013, official data showed on Thursday, highlighting the risk to China's banking system from bad debt as the economy slows.

The NPL ratio for China's banking system rose 0.03 percentage points to 1.0 percent, the China Banking Regulatory Commission said in a statement on its website, the highest ratio since end-2011.

Non-performing loans rose to 592.1 billion yuan ($97.7 billion), 28.5 billion yuan above the outstanding amount at end-September. But the latest increase was lower than the 33.5 billion yuan rise in the first quarter of 2013.

The weighted average capital adequacy ratio of Chinese banks was at 12.19 pct as of the end of December, up slightly from 12.18 percent at the end of September,

A higher capital adequacy ratio is seen as positive for financial stability, as lenders have greater capacity to absorb losses from bad loans. The downside for investors is that higher capital adequacy crimps a bank's return on equity.

Bankers and analysts expect bad loans to rise further this year as economic growth slows and banks deal with the aftermath of the huge lending binge that policymakers unleashed to soften the impact of the global financial crisis in 2008.

"We believe Chinese banks' loan quality will deteriorate noticeably in 2014," Liao Qiang, senior director at ratings agency Standard & Poor's wrote in a report released on Thursday.

"Banks remain heavily exposed to debt-laden local government financing platforms and manufacturers (such as steel and cement producers) are saddled with overcapacity because China's decade-long construction boom is cooling," Liao wrote.

Many analysts believe China's true NPL ratio is higher than the official figure, as banks can disguse bad loans by rolling them over.

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