Chinese bank credit continues to build up despite deleveraging campaign

Sustained expansion in household debt pose risks to the sector’s stability.

Even as China intensifies its campaign to rein in risk in the financial system, credit continues to build up within the banking system to undermine the crackdown, according to credit rating agency Fitch. 

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“Despite the authorities’ deleveraging efforts, overall credit continues to build up within the financial system. As such, Fitch expects asset quality pressures to remain although reduced economic headwinds, if sustained, could lower pressure in the short-term,” said Grace Wu, head of China bank ratings at Fitch.

This comes as the operating environment of Chinese banks remain negative even as Fitch upgraded the viability ratings of three of the country’s largest state banks, China Construction Bank, Industrial and Commercial Bank of China and Bank of China from BB to BB+, amidst concerns that the slowdown in credit may continue if economic growth falls short of government targets.

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“Our outlook on China’s operating environment may improve if we gain greater confidence that the deceleration, especially in shadow activities, will reduce contingent risks and increase transparency,” Wu added.

At the same time, sustained expansion in household debt as a percentage of GDP continues to pose risks to the banking sector which could even trigger a possible downgrade if risks continue to mount. In fact, a report from the Bank for International Settlements notes that Hong Kong and China are amongst the economies that are at the highest risk to a banking crisis due to worsening credit-to-GDP gaps and debt service ratio. 

Credit to GDP serves as a useful early warning indicator for a banking crisis as it measures the risk associated with credit given to households and businesses. China's credit-to-GDP gap is in the red at 16.7 which is long beyond the acceptable ratio of 9 whilst DSR is at 5.1 even though the acceptable range is 1.8.