SHANGHAI A stress test by China's central bank showed the banking system can weather big increases in bad debts or a sharp economic slowdown, but some analysts were skeptical about the findings aimed at shoring up investor confidence.
Concern about huge growth in Chinese corporate debt since the global financial crisis and the risk of defaults has intensified this year as growth slows and authorities allow markets to play a bigger role in deciding winners and losers.
"The results of the stress test showed that the asset quality and capital adequacy of China's commercial banks is relatively high," the People's Bank of China (PBOC) said in its annual financial stability report released on Tuesday.
The central bank carried out stress tests at the end of last year for events such as a 400 percent rise in non-performing loans (NPLs), increases in bond yields, large changes in the yuan's exchange rate, and economic growth slowing to 4 percent.
Another worst-case scenario tested was a 15 percentage point rise in non-performing loans of local governments and industries with excess capacity.
The tests covered 17 domestic banks that are considered systemically important and account for 61 percent of assets.
"Under light, middle and heavy stress scenarios, the banking system's overall capital adequacy would remain at a relatively high level; even the most serious scenario would not see the capital adequacy ratio fall below 10.5 percent," the report said.
That would be a fall of about 1.5 percentage points in the current level of the ratio.
However, the PBOC did say that under the worst-case scenario, three banks would fail to meet liquidity ratio requirements. It did not name those banks, nor did it release any results for individual banks.
Commercial banks are required to keep their liquidity ratios at 25 percent or higher.
Concern about Chinese corporate debt has intensified this year as the economy loses some momentum and after Shanghai Chaori Solar Energy Science and Technology became the first Chinese issuer to default on a public domestic bond in March.
Chaori's unprecedented default signaled to the market that local governments may no longer bail out troubled firms, forcing market participants to reassess credit risk.
The stress tests did not investigate the hundreds of smaller commercial and rural banks. These smaller lenders are seen as more vulnerable to slowing growth and rising bad debts, and their problems draw great media attention, but they are not considered to pose a broad systemic threat. <ID: nL4N0MO15S>
The China Banking Regulatory Commission (CBRC) plans to conduct regional and national stress tests after banks saw a spike in bad loans last year, official media reported earlier this month.
Chinese banks' NPL ratio rose to 1.0 percent at the end of December, its highest level in two years, the CBRC reported in February. But many analysts believe true NPL ratio is higher as banks can disguise bad loans by rolling them over.
The banking regulator has conducted stress tests before, but analysts are suspicious about the reliability of the findings given such test may fail to reflect the real economic changes.
For example, China may see widespread job losses if the country's economic growth dips to 4 percent, which could in turn lead to rising defaults among home buyers, said Lu Zhengwei, chief economist at Industrial Bank in Shanghai.
"The results from the stress test are relatively optimistic. The tests are meaningful but we must pay attention to possible risks from dynamic changes," said Lu.
The government aims for 7.5 percent annual growth this year, and China's Premier Li Keqiang has said that the economy must grow 7.2 percent annually to create 10 million jobs a year.
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.
The economy grew 7.4 percent in the first quarter but China's resource-dependent and manufacturing-heavy provinces suffered the sharpest growth slowdown in the first quarter, with annual growth in Hebei province, the nation's top steel producer, tumbled to 4.2 percent in the first quarter.
Chinese policymakers are pushing for a deleveraging process to cope with the hangover of the lending binge under a huge stimulus to counter the impact of the global crisis in 2008-09.
Banks have been told to curb lending to local government financial vehicles and industries facing overcapacity, forcing them to turn to shadow financing channels, such as trust loans.
Nicholas Borst at Peterson Institute for International Economics, believe that a 50 percent drop in housing prices could bring the NPL ratio to 6.6 percent, as real estate loans account for a fifth of the total loan book of commercial banks.
"A sharp correction in real estate prices would put many of these loans into default," he said in a research report, adding that the bulk of the defaults would likely come from highly leveraged property developers, rather than households.
"This would be a painful shock to the banking system, but manageable given high capital buffers."
(Reporting by Pete Sweeney; Additional reporting by Chen Yixin, Kevin Yao and the Shanghai Newsroom; Editing by John Mair & Kim Coghill)
(This story refiles to fix a word in the 22nd paragraph)