Dependence on troubled SOEs puts banks at risk

Leading commercial lenders need to break away from business as usual

State-owned Sinosteel Corp acknowledged Tuesday that it is struggling with financial issues, but denied earlier reports which stated that it had defaulted on tens of billions of yuan in loans to domestic banks. For their part, China Minsheng Banking Corp and Industrial and Commercial Bank of China refuted the default reports as well.

Whatever the situation may be with Sinosteel's outstanding loans, it's hard to deny that the balance sheet of this once mighty steel trader has taken a pounding over recent years as decelerating GDP growth crimps upstream demand. Indeed, structural imbalances in the Chinese economy mean that many large State-owned enterprises (SOEs) are now in the same boat as Sinosteel. As pressure mounts in traditional sectors - particularly steel, coal and cement - the likelihood of an SOE default has never looked greater. China's commercial banks need to take note of this situation and stop betting on the implicit political supports of large-scale SOEs when it comes to making loan decisions.

As many know, China's leading commercial banks have long been reluctant to lend to small-scale private companies and start-ups. Instead, they often reserve the bulk of their lendable capital for SOEs with huge portfolios of assets in key industrial sectors. But with the slowing of China's economic engine and policy efforts to wean the country away from investment-led growth, these favored sons are now finding it harder to cover their debts.

The coast may be clear for the moment with Sinosteel, but banks cannot afford to wait for a real implosion before they take action to raise asset quality. Sitting passively by will only make things worse. In fact, many would say that local banks are already in a dangerous place with their bad loans.

By the end of the first half, China's top 10 listed banks had 519.76 billion yuan ($ 84.83 billion) in bad loans on their books, representing an increase of 70.6 billion yuan, or 15.71 percent, from the end of 2013, according to a report issued in September by PricewaterhouseCoopers (PwC). Over the same six-month period, the PwC report also noted that the nonperforming loan ratio of these banks had increased to an average of 1.06 percent from 0.99 percent, while overdue loan ratio rose from 1.29 percent to 1.63 percent.

With data also showing slower growth in both deposits and net profits at China's largest commercial banks, these institutions should explore innovative ways to strengthen their loans and develop new services that can bolster earnings.

China's financial authorities have long been calling on banks to pare down their bad loans. Early in 1999, four companies - Huarong Asset Management, Cinda Asset Management, Orient Asset Management and Great Wall Asset Management - were established to take over the bad loans of China's leading lenders. In 2012, officials also released guidelines that would allow local governments to establish regional asset management companies that could absorb bad loans as well.

Banks have taken their own steps to cut their bad loan ratios. In September, for instance, Bank of China dealt with some 27 billion yuan in bad assets through market-oriented measures in the first half.

Domestic banks also need to explore new products and lines of service that can meet the demands of consumers. Of course, this won't be easy considering the challenges facing these institutions, not least of which being their inexperience in many innovation-driven market segments. In the future, for example, traditional banks need to work with Internet financial companies to bring their services online. The explosive popularity of Yu'ebao and other online products which have siphoned hundreds of billions of yuan away from traditional savings accounts highlights just how much banks have to gain - and lose - in China's increasingly liberalized and market-oriented financial sector.