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Mainland China and India, emerging Asia's largest economies,
have introduced multiple policies to help borrowers and banks
during the COVID-19 pandemic. However, these measures have
exacerbated underlying risks in the banking sectors notably credit
and asset-quality risks.
Mainland China
Since COVID-19, a number of policies have been introduced in
mainland China. These include a loan-payment moratorium for MSMEs
until March 2021, non-performing loan (NPL) classification
relaxation for MSME loans, more rediscounted loans to banks (with
80% of the loans earmarked for MSMEs), increased relending and
rediscount quotas for smaller banks, and a lower reserve
requirement ratio for these banks.
An extension of the policies introduced before COVID-19 will
increase liquidity for smaller banks and boost lending to MSMEs,
while at the same time they are likely to introduce more risk. MSME
loans had already risen by 50% in the first six months of 2020
versus the end of 2019. Given the weakness of demand because of the
COVID-19 pandemic, more MSME repayment difficulties are likely to
come when the moratorium expires in March 2021 (between
end-February and end-March 2020, nearly 130,000 companies have
de-registered). As of the first quarter of 2020, city commercial
banks and rural commercial banks accounted for 50.9% of total micro
and small loans outstanding but only 30% of total sector assets as
of mid-2020. Given historical concentration in lending to MSMEs,
the risks will fall disproportionately on smaller banks, compared
with large banks' natural clients of large corporates. Smaller
banks also face tighter liquidity positions with greater reliance
on interbank depository notes and lower capital buffers to deal
with a surge in defaults.
The mainland Chinese authorities have acknowledged that NPLs
will rise in the next 12 months, and to support these smaller
banks' likely worsening asset quality and subsequent falling
capital base, the central government allowed local governments to
use part of the proceeds raised from the sale of local government
bonds to purchase convertible bonds from small and medium-sized
banks in July 2020. The recent stake purchase of Huishang Bank, a
small bank, by People's Bank of China's Deposit Insurance Company
suggests the state is willing to provide support for smaller banks.
If the convertible bond options are trigged by the local
governments, they are likely to become part owners of these banks.
On the one hand, this suggests more security for these banks; on
the other hand, this likely means lending will be ensured for
particular areas and sectors.
India
For India, IHS Markit had been concerned about the country's
high levels of NPLs, which as of March 2020, stood on average at
8.5%. State owned banks are weak capital buffers at 13.1% which is
lower than the sector average of 14.8%. Adding to concerns is the
historical reliance on government capital injection. A key measure
to address the last issue was the consolidation of state-owned
banks which was completed in March 2020. Given their bigger size,
it is expected that they will more easily tap financial markets for
funding rather than the government.
Since the COVID-19 outbreak, the Reserve Bank of India (RBI) has
introduced multiple banking policies. These include loan
moratoriums, delayed implementation of the last tranche of the
Basel III capital conversation buffer and implementation of the net
stable funding ratio, and the potential introduction of a "bad
bank". These are all expected to reduce immediate capital pressure
on Indian banks and temporarily alleviate the historic concerns for
India's banking sector risks.
The RBI's Financial Stability Report (July 2020) shows that, in
the worst-case scenario (GDP falling by 8.9%), the banking sector
is likely to see its NPL ratio rising from 8.5% in March 2020 to
almost 15% by March 2021. For state-owned banks, the NPL ratio is
expected to rise from 11.3% to more than 16%. Because of the
COVID-19 pandemic, the RBI expects that five banks will have a
capital adequacy ratio of below 9% in the most severe case,
providing further support for state capital injections. The
government has noted that it is willing to provide capital
injections wherever needed. This is a big change from the budget
last fiscal year when the government budgeted virtually no capital
injections for 2020/21 with the expectation that the large capital
injection by the Bharatiya Janata Party (BJP) government to the
merged banks in 2019 would already be sufficient.
Implications and outlook
The COVID-19 force majeure event makes it easier for the
government to implement its plans and garner support from the
public. This, in turn, will encourage expanded direct lending to
state-preferred/priority areas and areas popular with voters. It
should be noted that state-owned banks often disburse over the 40%
required level of priority area lending. as well as higher lending
to the public sector where state-owned banks lend multiple times of
the proportion of their total loans to public sector when compared
to private-sector banks. This could lead to a vicious cycle in
which more loans are given to high-risk areas because of continued
state-owned and state capital injections. The subsequent increase
in state ownership will encourage even more lending to high-risk
areas thus intensifying state-owned banks' role as a policy
vehicle.
Over the next 12-24 months, the policies enacted will impact on
the reporting of credit risk and will lead to an eventual surge in
impairment. To compensate for such deterioration, capital-raising
will be needed, which in some cases has already started. For
smaller banks in mainland China the authorities are likely to
provide continued support. In India the national government is
likely to take a larger role in owning banks. Overall, under the
current trajectory, this may prevent India from privatizing more
state-owned banks, reversing our previous expectation that after
completing mergers and capital injections the government would
start looking at privatization options for major state-owned
banks.
Posted 31 August 2020 by Angus Lam, Senior Economist, Country Risk