Photo: flickr / Hipnos
The city of Wenzhou in China’s Zhejiang province has a potentially nasty credit crunch on its hands.According to Reuters, the Wenzhou banking sector’s non-performing loan ratio surged in the first half of this year to the highest it’s been in a decade.
The ratio more than doubled from 1.33 per cent in January to 2.69 per cent as of the end of June.
Zhang Zhenyu – the official responsible for regulating Wenzhou banks – said commercial banks in the city are well positioned to absorb NPL ratios as high as 4 to 5 per cent, according to Caixin Online. He also said only 0.5 per cent of the NPL’s or less than 1 billion yuan were expected to default.
Worrisome sign for the birthplace of China’s shadow banking system
It’s clear that investments are starting to go bad in the traditional banking sector in Zhejiang, and that could be ominous for the country’s enormous shadow banking system, which comprises around 20 per cent of all of renminbi-denominated loans in China. After all, shadow banks lend to much riskier borrowers who can’t typically get loans from traditional banks.
In a recent report, Bank of America’s David Cui explained that a slowdown in China could put the shadow banking system at risk, especially in Wenzhou which Cui refers to as “the birthplace of China’s underground lending market”:
To pay for high returns demanded by investors and depositors, shadow banks need to deal with relatively high-risk customers. The modest profits recorded by small lenders in Zhejiang in recent years demonstrate that the legal returns of many shadow banks may not be that attractive.
As such, it’s not a surprise to us that many of them appear to be no more than a leveraged play to arbitrage between official (low) interest rate and market driven (high) interest rate. With this type of business model, the music tends to stop when loan demand starts to weaken and their investments start to go bad. Their thin capital base can be wiped out fairly quickly when this happens.
If the shadow banks start to melt down, the effects will feed back into the traditional banking sector and make those non-performing loan ratios look a lot worse.
The final line of the Reuters article perhaps says it best: “However, many private analysts believe the real figures could be much higher.”