China’s big four banks: expansion abroad, trouble at home

At the end of 2014 China’s biggest bank the Industrial and Commercial Bank of China (ICBC) held an astonishing US$ 3.3 trillion in assets, while the second largest, China Construction Bank Corporation weighed in with a hefty US$ 2.6 trillion. These two giants along with the Bank of China and the Agricultural Bank of China, make up the “big four” national banks that dominate Chinese internal lending and deposit taking as well as driving commercial activity across the country.

As if the figures above are not enough, across the entire banking industry total assets had grown to a head spinning US$ 28.5 trillion by the end of 2014 (a 13% increase in that year alone). The big four’s return on assets at the end of 2014 remained strong at 1.26% outperforming regional peers such as Japan, Malaysia and Australia. On these results China’s banks looked to be world beaters – indeed the “big four” made up 4 of the 5 largest banks in the world as measured by total assets.

Cloudy Outlook

However at the same time trouble is brewing, the banking sector’s non-performing loans (NPLs) climbed from 0.95% to 1.22% over 2014, a worrying jump, but not yet in the danger zone, at least if you choose to believe the official figures.

Many doubt the quality of the big four’s official NPL figures arguing that too much money has gone into uncreditworthy projects with state owned enterprises and the real NPL rate is much higher than what is reported by the banks. This could be papered over in times of strong growth and a rapidly growing loan book, but a slowing economy threatens to expose the problem of NPLs, particularly lending to state owned firms, which are more likely to remain inefficient, loss making and politically well-connected and as result less concerned about paying back loans. Researchers and Chinese banking experts estimate the real NPL figure to be anywhere between 6 -21%, citing interviews with companies and detailed analysis of firm’s repayments to banks.

Investors have taken this into consideration and major banks trade at a price to earnings ratio of around 5 due to fears around these hidden bad debts on the their books.

Chinese banks’ have followed a state led strategy of funnelling the country’s massive pool of deposits into projects run primarily by state owned enterprises. This stepped up a gear after the financial crisis and credit growth has exploded to what some believe are dangerously high levels, total domestic credit as a percentage of GDP stood at 162% in 2014, (compared to 159% in Australia) and continues to rise.

Tough Decisions

The short term future for Chinese banks looks fairly tough, restricting credit will further slow the economy and push non-performing loans higher, but increasing lending could just mean kicking the can down the road and facing a bigger NPL problem in a few years time. In addition political pressure to lend to state owned firms could potentially starve the more profitable private sector.

The situation is a potential timebomb as if the economy really grinds to a halt then bad debts could wreck or severely hamper an economic recovery.

This scenario is tempered by the fact the government has recognised the problem of bad debt and excess lending (although it is not clear how it will combat it) and will do almost anything to stop these bad debts adversely affecting the rest of the economy.

One way Chinese banks can improve their prospects is by expanding abroad, diversifying revenues and risk as well as gaining further international experience.

To what extent have the big four gone global?

In 2013 ICBC became the first Chinese Bank to dip their toes into the US market. acquiring the US based East Asia Bank. Another interesting strategically minded ICBC deal was taking a 20% stake of African focused Standard Bank, a match which looked ideal on paper given China’s interests on the continent. It should have dovetailed ICBC’s financial firepower with Standard Bank’s decades of African experience, but so far the deal has not gone to plan and the hoped for synergies have not emerged.

Bank of China has also gone abroad to seek its further fortune: Xiao Gang, chairman of the board of directors of Bank of China, explained in June 2012 why the bank must go global:

“There is good reason to believe that the Chinese economy has reached a point where its status as the biggest country will lead it to become the biggest in out¬bound direct investment.This new model not only requires Chinese enterprises to expand their global businesses, but also China’s banking sector to accelerate its in¬ternationalization,” Xiao wrote.

Making good on this promise the Bank of China has expanded into South America, Europe, Africa and other parts of Asia by opening new branches and now has a presence in 38 countries, making it the most global of the big four.

Overall the big four have become more international through acquisitions and branch growth at a rapid rate in recent years, but still only make around 10% of their revenues overseas. It will be interesting to observe whether the banks continue this trend in light of the domestic slowdown, a globally diverse asset base is a good hedge against problems at home, but these banks remains state controlled and the government may well decide that in the short term resources need to be focused on China, particularly when capital outflows are at a record high. Also Beijing already has experienced policy banks well able to carry out overseas initiatives like the Belt and Road project.

These next few years will determine whether the big four can move from away from being domestic powerhouses weighed down by bad debts or global spanning, innovative financial institutions able to compete with the major US and European investment banks.