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Over the past month, Industrial and Commercial Bank of China claimed – or, more correctly, reclaimed – the honour of being the world’s biggest bank by market capitalisation.
ICBC’s ascent – deposing the US’s Wells Fargo which briefly held the top spot – is a reflection not of anything the bank did in recent weeks but rather of the shifting tides of investor sentiment. Chinese bank shares have risen about 20 per cent since the end of June, a rally that propelled ICBC to a market value of $230bn, $5bn more than Wells Fargo.
Sentiment can turn just as quickly and strip ICBC of its crown. But for the time being, ICBC’s return to the head of the global bank tables is a good moment to look at what is going right in the Chinese banking sector.
The bear case for China’s banks is well known. Their lending growth over the past five years has been unsustainably fast. Bad debts are starting to surface. A big rise in shadow banking has saddled them with hidden liabilities. Interest rate liberalisation will eat into their cosy margins. On top of that, growing competition for deposits is driving up their cost of funding. All in all, there is plenty to keep Chinese bankers up at night.
But ICBC’s strong run recently shows that there is also a bull case to be made for Chinese banks. It is not a popular story. Even after the rally, investors are still sceptical about the true worth of Chinese banks. ICBC is trading on a 2013 price-to-earnings ratio of 6 – a significant discount to its global peers. Wells is on 11 and HSBC is at nearly 13.
The bull case begins with the simple observation that investors have consistently underestimated the profits of Chinese banks. Their second-quarter results, announced at the end of the August, were the latest example. Earnings were about 5 percentage points higher than market forecasts, and that was after upward revisions of 15 per cent in the 10 months leading up to the results, according to Mike Werner, an analyst at Sanford Bernstein. Past performance is, of course, no indicator of future gains. But consistent outperformance should at least give pause for thought.
The banks’ resilience stems in large part from the fact that bad loans have remained a minuscule portion of their assets. Headlines have focused on the absolute increase in banks’ non-performing loans: a Rmb13bn ($2.1bn) jump in the second quarter, the seventh straight quarterly increase. However, bad loans are only 0.96 per cent of their overall books and have been stable at that level over the past few years.
The obvious riposte is that non-performing loan ratios have remained low only because overall lending growth has been so fast, effectively covering up the true extent of the rot. As China’s economy slows, the deadwood will emerge. But it is unlikely to be so automatic, and Chinese regulators are not exactly asleep at the switch. First, they have given banks the go-ahead to resume securitising their assets, providing an outlet for disposing of bad loans. Second, they have permitted the creation of new provincial-level asset management companies – effectively, bad banks – to deal with bad loans. Third, they finally appear to be serious about local government debt, ordering a detailed audit of the extent of the problem and weighing policies to reduce the future spending burden of cities and towns.
The banks’ resilience stems in large part from the fact that bad loans have remained a minuscule portion of their assets
Credit Suisse analysts hailed the possibility of “breakthroughs” in fiscal reforms yesterday in upgrading Chinese banks to an overweight rating from underweight.
Finally, the prospect of a big wave of equity issuance – a dark cloud over Chinese banks for several years – is beginning to recede. The country’s five biggest banks already have reasonable capital buffers. All are above the 11.5 per cent capital ratio required of systemically important institutions under the new Basel III rules. For weaker banks, regulators are expected to allow them to issue preferred shares, which would let them raise more equity without causing any immediate dilution for shareholders.
But that will only be a sideline event: the biggest source of fresh capital for Chinese banks is still far and away retained earnings, not new equity.
After ICBC’s results at the end of August, Jiang Jianqing, the chairman, expressed frustration at investors’ gloomy view of his bank. “Such good profits, returns and quality. It’s all a little bit unfair,” he said.
With ICBC’s return to the top rank of the global banking order, Mr Jiang must believe that the universe is at least a little bit fairer than before.
Simon Rabinovitch is the Financial Times’ Shanghai correspondent
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