Why Chinese Banks Won’t Default

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Photo Credit: Bloomberg

The Chinese government ordered the nation’s five largest banks to raise their coverage on bad loans to 150% of the current amount in default. Previously, the banking industry looked to cover 130% of bad loans; however, weakening exports have sent the government preparing for more loan defaults.

Hunkering down in recession

Though there is no indication that loan defaults will or have risen, the government announced that the move should be implemented to remain on the prudent side of an industry riddled with collapses. The move will force banks to stockpile capital equal to 50% greater than the current value of loans in default.

Beating inflation

Analysts have suggested that the move may be a plan to curb inflation by tying down bank assets so that excess capital cannot be lent and leveraged through the financial system. By increasing the amount that banks have to keep in “reserve” against bad debt, the amount of capital that can be lent at any one time is severely limited. At present, only 2.45% of total assets in China’s banking system are in default, making it one of the best performing financial systems – giving rise to the idea that the new measures have little to do with defaults and more to do with inflation.

Chinese banks remain excellent investments

The Chinese banking system could not escape the fears of a world-wide banking crisis, and most banks trading for a respectable PE ratio of 8-10. At this point in time, any bank that can draw a profit is a buy, and China’s banks qualify. Dividend yields on Chinese banks are extremely high, with Industrial & Commercial Bank of China posting a 4.6% dividend yield at the current price of $3.19 per share. The stock is still off nearly 50% from its 52-week high of $6.33 per share, but well off market lows of $2.16 set during the fall 2008 credit crunch.

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