ICBC breach of bad-loan buffer shows China banking stresses

[SHANGHAI] Industrial & Commercial Bank of China Ltd's breach of a regulatory requirement for bad-loan provision coverage added to signs of growing stress in the nation's banking industry.

ICBC avoided reporting a quarterly drop in profit on Thursday by letting provisions fall to 141 per cent of existing nonperforming credit, below the 150 per cent level required by the China Banking Regulatory Commission. The move let it eke out a 0.6 per cent gain in net income for the first three months from a year earlier.

Breaches by ICBC and, earlier this week, Bank of China Ltd, highlight the lenders' struggles to preserve profits as an economic slowdown and government measures to curb overcapacity in manufacturing trigger company defaults. Bad loans are at the highest level since 2006, putting at risk more than a decade of annual profit gains for the big lenders.

In an e-mailed statement, Bank of China said its provision coverage remained relatively high, exceeding an average of about 79 per cent for global systemically-important banks. The lender, which has stepped up its write-offs of bad loans, said falling coverage ratios were a trend across China's banking industry as asset quality came under pressure.

Agricultural Bank of China Ltd yesterday reported a 1.1 per cent quarterly profit gain and a coverage ratio of 180 per cent. Bank of Communications Co posted a 0.5 per cent gain and a 151 per cent ratio.

The government may let banks convert some bad loans into equity - a tool used to bail out the banking system and state-owned enterprises in the 1990s - and lenders may also be betting on an imminent relaxation of the provision coverage ratio, which was increased to 150 per cent in 2009.

"Banks must have communicated with the regulator before pushing down the coverage ratio, for sure," said Chen Shujin, an analyst at DBS Vickers Hong Kong Ltd. Lenders won't be punished because the ratio is on the verge of being reduced, she said.

Ms Chen estimated that ICBC would've reported a 2.5 per cent profit decline without paring back its provision coverage. ICBC shares dropped 1.2 per cent in Hong Kong as of 10:51 am, matching the decline in the benchmark Hang Seng Index.

Analysts including Sophie Jiang, of Nomura Inc in Hong Kong, have said the ratio could be reduced to 120 per cent without risk to the financial system. Prior to the global financial crisis, the ratio was at 100 per cent.

On Monday, the chairman of China Construction Bank Corp said that a reduction in the ratio to about 120 per cent to 130 per cent would be "reasonable" and "possible."

The regulator "may differentiate among different banks on ratios," Wang Hongzhang said. Bank of China breached the requirement for the first time by reporting a 149.1 per cent ratio.

While the economy is showing signs of stabilizing, improvements have come with a surge in borrowing that's pushed debt to the equivalent of 247 per cent of the economy, according to a Bloomberg Intelligence estimate.

China may have US$1.3 trillion of loans to borrowers without sufficient income to cover interest payments, with potential losses equivalent to 7 per cent of gross domestic product, according to an International Monetary Fund report this month.

IMF staff members also this week joined a chorus of skeptical voices by saying that debt-for-equity swaps could let debt-laden "zombie" companies stay afloat and create conflicts of interest for bankers.

The challenge of rising soured credit is one reason that China's five largest banks are trading in Hong Kong at an average of about 0.62 times estimated book value, close to February's record low of 0.55 times, according to Bloomberg-compiled data.

Analysts say banks' official bad-loan ratios are understated, estimating the true number for the industry may be several times higher than last year's 1.67 per cent of total credit.

Alongside bad loans, lenders are grappling with sinking margins after the central bank cut interest rates six times since November 2014 and removed a cap on deposit rates. ICBC's net interest income fell 5.2 per cent in the first quarter after its net interest margin narrowed by 19 basis points.

BLOOMBERG