China's regional banks hit by economic slowdown, bad loans soar

BEIJING (Reuters) - Small banks in Chinese provinces affected by Beijing’s efforts to slash excess industrial capacity and reduce pollution are being hit by a spate of non-performing loans, according to reports from Chinese credit rating agencies.

Some small lenders in provinces such as Henan and Guizhou have seen their capital adequacy ratios fall to near zero or even negative due to the increase in bad loans, the reports say.

The troubles facing the regional lenders have been masked by slow overall bad-loan growth in China this year as big state-backed banks register faster profit growth.

At least 13 lenders, including 10 rural commercial banks, have had their credit ratings cut or outlooks downgraded to negative since the start of 2017, according to a Reuters analysis of 271 reports issued by several domestic ratings agencies.

The reports attribute the rise in bad loans to small business failures as the local economy stalls, as well as the closure of factories and mines as part of Beijing’s campaign to slash excess capacity and curb pollution, hurting the ability of companies to repay debts.

Many small banks are racing to replenish their capital to raise additional funds as provisions against non-performing loans. The spate of ratings downgrades is making it harder for some of them to raise funds in capital markets.

“Small banks are the main forces for small business financing,” said Xu Chengyuan, chief analyst at Golden Credit Rating International Co. “Under capital constraints, they have to reduce lending.”

A shrinking of credit could have serious implications for regional economies, said Xu.

For now, the provinces of Guizhou, Henan, Liaoning, Shandong and Jilin have the highest non-performing loan ratios in China, according to Citic Securities.

But risks could spread to more regions if companies are increasingly hit by Beijing’s financial deleveraging campaign, which has pushed up borrowing costs and reduced credit availability, analysts say.


In Shandong, where industries like coal, steel and aluminum account for 70 percent of industrial output, the ratings of four regional banks have been downgraded or had their outlook cut since December due to surging bad loans, the Reuters analysis shows.

The non-performing loan ratio of one of the lenders, Shandong Guangrao Rural Commercial Bank, jumped to 13.9 percent at the end of 2017 from 2.47 percent in 2016, while annual profit plummeted 99 percent to 1 million yuan ($146,618.97) from 197 million yuan over the period.

The bank declined to comment.

The soaring rate of bad and overdue loans at the bank resulted from the bankruptcies of local tyre companies hit by the excess capacity and pollution clampdowns, according to a report from Golden Credit Rating.

In the southwestern province of Guizhou, Guiyang Rural Commercial Bank was downgraded by China Chengxin International Credit Rating Co to A+ from AA- in June after its bad loan ratio soared 15.41 percentage points last year to 19.54 percent.

The rise was also triggered by stricter rules on classifying bad loans imposed by the banking regulator, the ratings agency said.

The surge in bad loans has almost wiped out its regulatory capital, its financial figures show.

The bank’s capital adequacy ratio dropped to 0.91 percent last year from 11.77 percent a year earlier, while its tier-one core capital adequacy ratio swung to negative 1.41 percent from 8.01 percent.

In central China, Henan Xiuwu Rural Commercial Bank had a non-performing loan ratio of 20.74 percent at the end of 2017, compared with 4.5 percent a year earlier, according to disclosures made by the lender.

With the jump in the bad loan ratio, the bank’s capital adequacy ratio swung to a negative 0.75 percent from 12.92 percent.

Calls to Guiyang Rural Commercial Bank and Henan Xiuwu Rural Commercial Bank went unanswered.

Analysts say stricter classification rules will lead to a further jump in bad loans at small banks that have been hiding them under the “special mention” category.

The rules, which require banks to classify all loans overdue by over 90 days as non-performing loans, is likely to lead to a 14-percent increase in such loans from 2017, and 95 percent of the impact will fall on mid-sized and small banks, according to a June report by UBS.

That will lead to a provisioning shortfall of 250 billion yuan, UBS estimated.


Small banks, most of which are unlisted, will have to rely on funding support from local governments and existing shareholders to boost capital, bankers and analysts say. But simple capital injections cannot resolve the fundamental problem of poor risk management.

Risks are more significant at rural commercial banks as they lack sufficient capability to diversify in terms of geography, industry or clients, analysts say. Many of the banks are involved in unregulated shadow financing, allowing them to circumvent rules capping a lender’s credit exposure.

Jilin Jiaohe Rural Commercial Bank was downgraded to A from A+ in February by Shanghai Brilliance Credit Rating & Investors Service Co partly because it had lent 601 million yuan in shadow loans via trust products to Cosun Group, which defaulted in a high-profile shadow banking scandal involving 14 financial institutions.

Small banks’ close ties to local governments also puts pressure on them to support often murky local government financing vehicles, said a source who deals with the products.

Guosen Securities Co estimates that Chinese banks are exposed to 28 trillion yuan of debt implicitly guaranteed by local governments, including 17.2 trillion yuan in on-balance sheet loans and 10.5 trillion yuan categorized as so-called non-standard investment, which typically refers to shadow loans.

Some local government funding vehicles have missed payments due to refinancing difficulties and weak local economic growth, dragging regional banks into a tough fight against rising bad loans and bureaucratic protectionism.

“Local governments had asked banks to give them money so we had to,” said one banker who requested anonymity. “But now they are saying ‘why did you lend it to me in the first place’”.

Reporting By Shu Zhang and Ryan Woo in BEIJING; Additional Reporting By Andrew Galbraith in SHANGHAI; Editing by Philip McClellan