China Risks

Exposed in the East

Yinchuan dpa picture alliance china
Booming constructions like this one in Yinchuan have left China with a lot of debt.
  • Why it matters

    Why it matters

    The failure of the Chinese economy could lead to significant write-downs of loans and dent the expansion hopes of some German banks.

  • Facts

    Facts

    • China’s total debts have almost quadrupled since 2007 to over $28 trillion in 2014, totaling 282 percent of the country’s economic output.
    • German banks have about $37 billion in outstanding loans in China; British banks more than $220 billion.
    • Experts have warned that significant write-downs might be necessary on some loans if Chinese growth falls back further.
  • Audio

    Audio

  • Pdf

It’s almost 8,000 kilometers from the German financial capital Frankfurt to Beijing, but the two cities are closer than you might think. The current economic crisis in the East, which has rocked global stock markets over the last fortnight, could prove expensive for Germany’s banks.

On the face of it, the Chinese financial market seems relatively isolated, but the latest figures show that Europe has become increasingly exposed over the past few years. Britain’s financial sector has more outstanding loans in the world’s second-largest economy than any other country, including the United States, but Germany’s financial sector has significant skin in the game as well.

German banks have lent around €33 billion, or $37 billion, to China as of the first quarter of this year. If we include Hong Kong as a financial center, loans from German banks come to almost €48 billion.

Martin Hellmich, a professor of risk management at the Frankfurt School of Finance, said that a further deterioration in the economic situation in China will not cause German banks to get into financial difficulties, but he did warn that “significant write-downs might be needed on some loans.”

For some banks that are already struggling to make a profit, this could have a visible impact on their return on equity, a measure of profitability, Mr. Hellmich said.

Some banks may also have to think twice about plans to expand their lending operations in the Asian powerhouse, which until the recent upheavals had been viewed as something of a holy grail for growth-hungry companies and banks.

About half of German loans have gone to other banks in China, which themselves are now having to cope with an increasing number of bad loans on the domestic market.

“Significant write-downs might be needed on some loans.”

Martin Hellmich, Frankfurt School of Finance

China’s total debts have almost quadrupled from $7.4 trillion in 2007 to over $28 trillion in early 2015. The state, provincial governments, companies and private households had debts amounting to 282 percent of the country’s economic output in 2014.

The total bad loans on the books of China’s four major state-owned banks also rose by 28 percent to 592 billion renminbi, or €83 billion, in the first half of the year. At the Agricultural Bank of China, the country’s third-largest bank by assets, the proportion of bad loans has grown from 1.2 percent to 1.8 percent in just 18 months.

Despite this, the banking sector has so far remained demonstratively calm. Few expect the current economic slowdown in China to turn into a full-blown crisis that could affect the banks’ bottom line.

Michael Kemmer, head of the association of German banks, said that growth rates in China will slow down noticeably, but emphasized that “there is no need to fear an economic slump, either in China or worldwide.”

He believes there has been barely any increase in the risks to German banks and said that debts owed to German banks by China are “very manageable”. They account for just 1.4 percent of all foreign lending by German banks.

Harm Semder, a senior analyst at rating agency Standard & Poor’s, also takes a relaxed view: “We don’t expect the upheaval in China to have any direct impact on German banks.” Ultimately, he said, banks’ direct exposure in China is manageable.

China has played down the risks, too. Wang Hongzhang, the chairman of China Construction Bank (CCB), has insisted that China is in a relatively good position compared with other countries and that bad loans do not represent a significant risk.

However, Helen Zhu from U.S. asset manager BlackRock believes that the risk arising from Chinese banks is much greater than the official figures suggest. Sandra Heep from Merics, a research institute for China based in Berlin, estimates that the proportion of bad loans could be closer to 10 percent.

 

German banks exposure in China Major Exposure-01

 

Meanwhile, regional governments are suffering from chronic funding shortages, leading some of them to turn to the shadow banking sector for support and resulting in escalating debts. The government in Beijing now wants to launch a large-scale debt restructuring program for local governments.

Ms. Heep of Merics does not believe this will be enough, and said that Beijing will have to redistribute tax money if it wants to get regional government debt under control.

Jing Ulrich, chief economist for China at U.S. investment bank JP Morgan, does not believe that the rising number of bad loans present a risk for China’s financial system. Part of the reason is that Beijing regards the financial sector as a key industry, and is therefore likely to step in with aid if needed.

All major banks belong to the state, and most of their loans have been granted to state-owned companies. Even if loans are not repaid, the state will bear the cost, either by rescuing the company that is experiencing difficulties or by helping out the bank in dealing with the bad loans, Mr. Ulrich said.

But even if European banks aren’t likely to go under because of China, the slowdown is likely to have consequences for German banks’ ambitious expansion plans.

One example is Commerzbank. The Frankfurt-based institution, Germany’s second-largest bank and a leader in loans to small and medium-sized businesses, wants to become the leading bank for corporate customer business between Europe and Asia.

Business in Asia has recorded double-digit growth rates in the last few years, with China the most important individual market. Commerzbank does not break down credit risk by country, but only by region. For Asia, it came to a total of €23 billion in the second quarter, which was 5.2 percent of the group’s portfolio. The bank said it is still too early to comment on possible effects from the disruptions in China.

Deutsche Bank, Germany’s largest bank, had a total exposure of about €14 billion in China last year, and is thought to be the biggest of all German banks in China. However, it accounts for only 1.4 percent of the bank’s total lending. This figure includes loans to Chinese subsidiaries of German companies, as well as derivatives and bonds. Deutsche Bank also refused to comment on potential risks to its Chinese exposure.

Compared with international competitors, bankers in Frankfurt can nevertheless relax as far as events in China are concerned.

British banks have invested more in China than the banks of any other country. The United Kingdom’s biggest bank, HSBC, revealed in its last quarterly report that outstanding loans in China had risen by a whopping 12 percent to $36.2 billion in its financial year to June 30. Rival Standard Chartered increased its lending in China by 30 percent to $58.3 billion over the same period.

This means that the British financial sector has more at stake than that of any other country. British banks have recently granted more new loans to China than U.S. and Japanese banks, making London institutions the most important foreign lenders to China, with a record total of $221 billion in outstanding loans.

Should a serious economic crisis occur in China, the consequences for the United Kingdom would thus probably be worse than for any other country. The shortest route from Beijing therefore doesn’t lead to Frankfurt, but to the City of London.

 

Michael Brächer covers financial markets for Handelsblatt in Frankfurt, Carsten Herz is a London correspondent and Stephan Scheuer covers China for Handelsblatt. To contact the authors: braecher@handelsblatt.com, herz@handelsblatt.com and scheuer@handelsblatt.com

We hope you enjoyed this article

Make sure to sign up for our free newsletters too!