China's Real Estate Crisis Is Now Threatening Its Banking Sector

Chinese banks are grappling with near-record-low valuations as investors express concern over their exposure to the troubled real estate sector.

Accounting for approximately 10 per cent of China's stock market value, the banking sector's decline reflects the perceived risk of an economic downturn in the country.

In mid-October, Bank of Cangzhou faced a rush of depositors seeking withdrawals, triggered by a social media post listing banks allegedly involved with debt-laden property developer China Evergrande Group.

Although Bank of Cangzhou denied the accuracy of the claims, stating its loans to Evergrande amounted to 346 million yuan, investors continued to worry about other banks, such as China Minsheng Bank and Agricultural Bank of China.

Despite listed Chinese banks reporting over 2 trillion yuan in combined net profit for 2022, investors remain sceptical. Bank stocks are trading at an average of 4.72 times earnings as of 10 November, close to the all-time low of 4.13 recorded in October last year.

The real estate sector represents 23 per cent of bank lending, with personal home loans comprising about 80 per cent of this amount, as reported by Asia Nikkei.

However, concerns persist as Chinese commercial banks hold 3.2 trillion yuan worth of nonperforming loans, equivalent to 1.62 per cent of all bank loans. Investors doubt the accuracy of this information and instead use real estate sales volumes as an indicator.

Property sales have declined since their peak in 2021, with Goldman Sachs estimating that Chinese banks may incur about 1.2 trillion yuan in real estate-related losses due to the property slump. S&P Global warned that credit extended to the real estate industry could erode banks' capital amid defaults by Chinese property developers.

Despite these challenges, China's government has not shown a willingness to take drastic action on nonperforming debt. New bank capital regulations set to take effect in January may loosen some conditions on loans for real estate development.

Since China's move to liberalise interest rates in 2015, net interest margins have reached all-time lows. This, combined with falling long-term interest rates and a peaked property market, has negatively impacted banks' earning structures, resembling Japan's situation after its asset-price bubble burst in the early 1990s.

Restoring investor confidence in Chinese bank stocks will hinge on recognising nonperforming loans and bolstering capital, according to Kinger Lau at Goldman Sachs.