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Are Chinese banks going the same way as Greece and Spain?

Tuesday, 3 Sep 2013 | 5:33 AM ET
People's Bank of China in Beijing, China
Getty Images
People's Bank of China in Beijing, China

Despite better-than-expected earnings from some of China's largest domestic banks, fears persist about risks in the sector, with one analyst arguing that the sector could soon follow the route of Greek and Spanish banks.

Last week China's Big Four banks reported combined first-half earnings growth of 12.5 percent, beating market expectations, yet many analysts remain bearish given the banks' deteriorating asset quality.

One key concern is the rising level of non-performing loans (NPL) - loans that borrowers are unable to pay back - which, according to Chinese government data, rose for the seventh consecutive quarter to 539.5 billion yuan ($88 billion) in the second quarter of this year.

(Read more: Behind China's shadow banking system)

Paul Schulte, CEO of Schulte Research International, said the amount of bad loans on Chinese banks' balance sheets had led him to draw parallels with Greek and Spanish lenders.

"Either the market is wrong, or the accounts are wrong," said Schulte, referring to the disparity between stock market valuations and their accounts.

"I tend to think that over a long period of time the market is right and this has been a two-year re-rating of Chinese banks...Mr. Market is telling us that the large banks [in China] are facing a similar situation to Spain and the small banks [in China] are facing a similar situation to Greece," he added.

Why Chinese banking is slowing down
Michael Werner, senior equity analyst at Sanford C. Bernstein, expects Chinese banks' earnings to surprise to the upside, but says that the sector is going through a slowdown.

Europe's debt crisis has put the single bloc's banking system under pressure, with Spanish and Greek lenders being among the hardest hit. Losses from bad loans and debt write-downs have led to the need for bailouts and recapitalization. Schulte said Chinese banks are going the same way.

"If you look at market cap [divided by] deposits for smaller banks in China, they are trading at a discount to Greek banks, and larger banks are trading at a discount to the Spanish banks," said Schulte.

(Read more: Ex-Greek minister: Greece needs a 40% debt haircut)

Other analysts told CNBC they were very concerned about a sudden and expected rise in bad loans on Chinese banks' balance sheets.

Paul Krake, founder of View from the peak: Macro Strategies, said this spike in NPLs would lead to the need for the government to recapitalize its banking sector, much like what happened in the late 1990s, when Beijing set up four state-funded asset management companies to take over the bad debts of the four biggest state-owned banks.

(Read more: China banks may need 'sticky tape' to hold together)

"At that time NPLs were at 1-2 percent, and then they [the banks] suddenly came out and said they were at 25 percent," said Krake.

"This is exactly what's going to happen, it won't be a gradual thing....We're going to wake up one Saturday morning and they'll be like 'well sorry guys it's actually closer to 20 [percent] and we're going to have to do a full recapitalization,'" he added.

Schulte said he saw NPL ratios advancing to between 9 and 13 percent.

"The number may be anywhere between 9 and 13 [percent] they may not be as high as 20 but they are certainly much higher than 1 [percent]," he added.

Official data puts the ratio of NPLs to total outstanding loans at around 1 percent at present, though many analysts say NPLs are under reported.

—By CNBC's Katie Holliday: Follow her on Twitter @hollidaykatie

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