If the coronavirus outbreak keeps Wang Zhi's shoe factory closed for much longer, the Chinese entrepreneur reckons he will default on a Rmb5 million ($1.1m) loan coming due in June.
With no end in sight to the health emergency that has killed more than 1,100 people across China, it is small corporate defaults such as this that threaten to cause big trouble for the country's banks.
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A prolonged crisis in which factories and shops are unable to do business would add as much as Rmb5.6 trillion in new bad debt for lenders, trebling non-performing loans, according to S&P Global Ratings, as companies struggle with repayments.
Bad debt across the banking system could rise from less than 2 per cent at the end of last year to 6.3 per cent of total assets, S&P research shows — a level not seen for two decades.
In response, financial regulators have been forced to roll back recent sector reforms and order banks to extend the terms of lending for businesspeople such as Wang, delaying the creation of new bad debt for at least a little longer.
"What I need most is an extension of my loan by another year. That will determine the survival of my factory," said the businessman based in the city of Jinjiang on China's south-east coast. "I am not optimistic banks will accept our terms since they are under pressure to reduce bad debt."
China's banking sector is already in rough shape.
A decade of excessive credit growth has saddled China's lenders with heavy bad debts.
Sharply declining economic growth — at a 29-year low in 2019 — and the trade war with the US have put additional pressure on balance sheets over the past two years.
The coronavirus outbreak that started in the central Chinese city of Wuhan in December has presented a new threat to many small and medium-sized companies that rely on bank credit to survive.
A formal quarantine zone covering at least 40 million people in the surrounding province of Hubei is still in place, keeping many businesses closed. But outside that area, tens of millions more people across the country are subject to other informal quarantines that have disrupted daily life.
The situation could knock more than two percentage points off gross domestic product growth in the first three months of the year, pushing it to as low as 3.2 per cent, according to ANZ Bank, and make debt repayment impossible for many companies.
Large, national banks have kept non-performing loan rates low but their stock prices have taken a hit following the virus outbreak. Hong Kong-traded shares in Industrial and Commercial Bank of China and China Construction Bank, two of the country's biggest lenders, both fell about 10 per cent during the 10 days following a central government announcement on January 20 that the coronavirus was spreading at an alarming rate.
But many small banks are deeply troubled and already have bad debt rates exceeding more than 40 per cent of their total loan books. In 2019, regional lenders including Baoshang Bank and Hengfeng Bank required government bailouts or other forms of intervention to stop systemic risk from spreading.
In particular, smaller banks located in areas at the heart of the public health crisis are feeling a much bigger impact than national-level lenders.
Chongqing Rural Commercial Bank, based in one of the cities hardest hit by the virus outbreak, will experience the greatest pressure on its net interest margin among listed Chinese banks, according to research from Morgan Stanley. It also has higher exposure to the small and medium-sized companies expected to struggle during the crisis.
"The resilience of China's banking system may be tested," wrote S&P Global analyst Ming Tan in a report.
A surge in bad debt would weaken banks considerably. Lenders' average provisions coverage — the capital held in reserve to cover bad debt — would drop to a dangerously low level of about 55 per cent, from 188 per cent, according to S&P. That in turn would lower lenders' tier one capital adequacy ratios by about 3.8 per cent, depleting the capital they have on hand to defend against a crisis.
The crisis has forced regulators to slow or reverse some recent banking sector reforms, delaying some short-term pain but potentially allowing a resurgence in some types of risky off-balance-sheet lending and an accumulation of more bad debt.
The China Banking and Insurance Regulatory Commission said in early February that it would extend an end-2020 deadline for new asset management rules meant to curb risky shadow lending.
"The risk is, with the loosening of these asset management rules, there's a loosening on shadow banking," said Aidan Shevlin, Asia Pacific head of portfolio management for global liquidity at JPMorgan Asset Management.
Over the past three years, the regulator has forced banks to recognise their true levels of non-performing loans. Now the CBIRC is calling for banks to extend loans for troubled companies.
The policy of extending loans will help some enterprises get through the tough period but according to Moody's will also cause "delayed recognition of NPLs if the disruption caused by the coronavirus outbreak is prolonged" — a trend that is likely to add to China's bad debt load later in the year or in 2021.
- Additional reporting by Xueqiao Wang in Shanghai.
Written by: Don Weinland and Sun Yu
© Financial Times