Chinese banks and slow-boiling frogs

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Put a frog in boiling water and it will jump out. Put a frog in cold water and slowly raise the temperature and he won’t notice – so the story goes.

This may not be the case for frogs, but investors in stocks of China’s big banks might find that it is better to spot major threats quickly than let reality sink in over time.

Hong Kong-listed banks in mainland China have lost around 15% this year, compared to just over 25% for banks listed in the MSCI World Index of Developed Markets. This gap has already narrowed significantly and could become even smaller. The MSCI World Banks Index lost 42% from its March lows, while Chinese banks only lost 17%.

The China Banking and Insurance Regulatory Commission warned in a press release last week that non-performing loans, which have barely increased so far this year, are likely to rise significantly. The government is demanding support from lenders riskier small firms. This large-scale Forbearance to borrowers will contribute to the non-performing loans in the longer term.

On Monday, the rating firm Fitch Ratings estimated that inefficient lending in the Chinese banking system as a whole was between 15% and 22% of gross domestic product at the end of 2019 – roughly unchanged from the level at the end of 2015. That would suggest that the non-performing loan ratio is already wide higher than the banks actually state.

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