After going through years of eruption, the growth of non-performing loans (NPLs) in Mainland commercial banks is showing signs of winding down (see Chart 1). In the fourth quarter of 2016, NPLs only grew 18.7% YoY, the slowest growth rate since 3Q2013. The slower growth of NPLs could be attributable to a higher comparable base and the improving economic environment.
Is the worst behind us?
The relatively slower NPL formation suggests that the overall performance of the banks’ portfolio has been improving (see Chart 2). Indeed, the aggregate NPL ratio moderated to 1.74% in 4Q2016, marking the first quarterly decline since 1Q2012. Notwithstanding the slight improvement, since NPL grew substantially during the period in both absolute and relative terms, it will take some time for the banking system to digest existing NPLs.
The good news is, with concerns of the economy being washed away, NPLs are set to become steady going forward. Among the different categories of NPLs, loss loans saw the most remarkable increase (+55.4% YoY). While this may appear to be worrying, we believe this reflects the writing off of bad loans by banks, and, therefore, it should have little negative impact on the banks’ performance going forward.
Meanwhile, it is noteworthy that the formation of substandard loans has declined significantly – it only grew 2.8% YoY in 4Q2016 (the slowest growth rate since 3Q2011), while the substandard loan ratio declined in three consecutive quarters. As substandard loans are perceived as an early indicator of loss loans, it suggests that the worst could be behind us.
Looking ahead
At the 15th Meeting of the Central Finance Leadership Group held on 28 February, President Xi Jinping suggested that a system should be put in place “as soon as possible” to strengthen macro-prudential supervision and co-ordination across government departments so as to prevent and safeguard against systemic risks.1 President Xi further elaborated that, with reference to international standards, clear supervisory requirements had to be set up to contain market chaos and crack down on illegal activities. These suggestions will work in tandem with the potential tightening measures mentioned in our article in the March issue of the Bulletin.
With pressure easing on the Mainland economy, loan demand could be on the rise in the near term. This is supported especially by the recovery of productivity in the industrial sector. Indeed, as suggested in our January Bulletin article, the improving industrial profitability would rejuvenate private sector investments. Given the improving demand and our expectation that the PBoC could tighten monetary conditions, the cost of financing could pick up in the near term (see Chart 3).
While key messages about deleveraging and risk mitigation have been clearly stated by the policymakers, more details of the execution plans may be delivered at the annual parliamentary sessions (Two Sessions) that will begin this Friday, 3 March. We will provide an update if and when necessary.
[1] www.People.CN
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