Fitch warns of hidden information risks in Chinese banks

What are the little-understood risks of China's 2009 credit boom?
The packaging of loans into wealth management products. In our view this is probably the most disconcerting development in the Chinese banking sector over the last couple of years. There is very, very bad transparency about this among Chinese banks and it has gotten worse in 2010. The banks have never been forthcoming about the nominal amount of loans they get rid of. The number we were able to track in the past was the number of wealth management products they issued, and we used that as an indicator of activity. The problem is, in 2010, a lot of banks have even stopped reporting that number, so we get growing distortions with limited data. But the market remains pretty active and it is growing.

We think the [official figure for] credit growth this year is likely to be 20%; but the real number is going to be well above that, because banks are getting so much lending through this packaging channel. There is a fair amount of money in that area which is not included in the official data, which means at a system level, the credit growth is understated. It also means that for banks participating in this activity, credit growth is understated.

The reason we have been raising concerns about the classification of [repackaged] loans in China, is because it takes much longer to recognise them in NPLs (non-performing loans). We are pretty concerned about their asset quality over the medium term -- a couple of years down the road.

Which banks have suffered the most capital deterioration?
It varies. ABC (Agricultural Bank of China), which is currently in the headlines, is most in need of capital. They need this IPO. Some banks didn't experience any deterioration in their capital ratio; other banks experienced very large deterioration, such as China Merchants Bank and Citic Bank. Both of them are among the most active in loan-repackaging into wealth products and we have downgraded them (in February 2010). We knew that CMB was about to raise capital and we took that into account, but our view is that their capital had deteriorated so significantly by the end of last year that capital raising would still only bring them up to a level where everybody else was.

Which banks are better capitalised and how will their fundraising activities help?
There is quite an amount of credit risk that we believe is hidden, and it's hard to evaluate what that number would be for each bank. So, even though a bank might look more capitalised than another, if it has a larger hidden risk, that capital could all be wiped out. So we try to stay away from concluding which is the best capitalised bank.

This capital-raising exercise is really not so much to fund operations as it is to mend a hole the banks created from last year's very rapid growth. In that regard, the fundraising exercise is not adding cash on hand but adding cash to absorb losses in the future.

How independent can these state-owned banks be?
You can certainly look at what happened last year and say they can't be that independent. The government told them to lend and they all lent. But if you think about it in a bigger context, about how far the banking system has come over the past 20 years, it's dramatically different than it was a decade ago when it really was very much directed by the central government. The government would say to banks you are going to lend this much to a certain company. At that time, all the credit decisions were made by the central government. We are not in that situation anymore. Now it is more macro type of encouragement and the government's guidance is directional. They will say we would like you to be more open to certain sectors, but they leave the banks to decide to which companies they want to lend.

How do you view the fact that banks favour big state-owned enterprises in their lending and ignore SMEs (small and medium-size enterprises), even though big companies have more cash than they need while SMEs are lacking?
This is one of the biggest financial sector development challenges that the government faces. The government needs to get the financing to trickle down beyond the state enterprise level. One of the negative things in 2009 was that banks were so concerned about the global environment and future asset quality. And whenever that happens they tend to flock to state-owned companies because they think they are safer. There was an over-allocation of the amount of lending to state-owned companies.  

But many of the SMEs have pretty poor disclosure of their accounts and it's difficult for banks to go in and assess what the company's cashflow is like.