×

China has started bailing out its banks, UBS says

The murky balance sheets of China's banks have long spurred fears of an impending crisis, but the clean-up may already be proceeding apace, UBS said.

"Contrary to prevailing market wisdom, we believe considerable progress has been made in recognizing and dealing with the problems," Jason Bedford, an analyst at UBS, said in a note Thursday, citing analysis of 765 banks on the mainland.

"Recapitalization and bailouts have started and made unexpected (and under-appreciated) progress," he said, adding that UBS research suggested 2015 was the first year since the early 2000s with sizable bank bailouts.

China's banking sector has long spurred concerns that its non-performing loans (NPLs) were grossly underreported and that lending too often was politically directed into industries with too much capacity. Separately, in a note Thursday, Daiwa said the sector's NPL ratio in the second quarter remained flat at 1.75 percent, while large banks saw their NPL ratio fall 3 basis points on-quarter to 1.69 percent, which it attributed to large NPL write-offs and disposals during the quarter.

During the global financial crisis, China's government used the banks to inject stimulus into the broader economy. As a result, debt levels rose sharply among local governments and state-owned companies and the banks now hold high volumes of non-performing loans — a problem that is worsening as industrial profitability falls and debtors struggle to service interest payments.

In February, storied hedge fund manager Kyle Bass warned that a Chinese credit crisis would see the country's banks rack up losses 400 percent larger than the around $650 billion equity hit that U.S. banks took during the subprime mortgage crisis.

Bass was famed as one of the few major investors to correctly call the U.S. subprime housing collapse that kicked off the 2008 global financial crisis. That prescience earned him a mention in Michael Lewis' book "Boomerang," which was about the European credit crisis.

But UBS' Bedford noted that China banks' write-offs and disposal of bad assets have risen three-fold since 2013. He said that 1.65 trillion to 1.8 trillion yuan (around $250 billion-$270 billion) worth of non-performing assets were written off from 2013-2015, citing a review of 173 banks' financials. That figure was equivalent to 2.05 percent of total loans or 142 percent of NPLs at the end of 2015.

"More surprising is the size of some individual bank bad asset disposals—many were equivalent in size to 4-15 percent of the banks' total loans," he said.

UBS estimated banks' total new equity issuance from the second half of 2014 to the second half of this year was around 620 billion yuan.

But that didn't mean all was sweetness and light for China's banks.

Bedford said much more needed to be done to clean up the banking sector, which had grown to 179 trillion yuan in assets.

"We believe that we are at the early stage of the process and that bad debt accumulation is significant and still rising," he said. "We also note that progress across the country was asymmetrical, with provinces with the weakest economic fundamentals (Inner Mongolia, Heilongjiang, Liaoning, etc.) recording the least progress in resolving issues at their local lenders."

He added that if credit continued to expand at two to three times the pace of gross domestic product (GDP) growth, the size of the problem could expand faster than the solution.

While Daiwa kept a negative call on China's banking sector, it didn't appear to expect a blow up, saying, "we do not believe the banks' NPL losses will all hit at once." But it added, "it could take years for them to clean up their soured loans."

Qilai Shen | Bloomberg | Getty Images

—Katy Barnato contributed to this article.

Follow CNBC International on Twitter and Facebook.

—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1