China's regulators to China's banks: Liar, liar, pants on fire

09/15/2010 10:30 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Even China’s banking regulators don’t believe these numbers. And now they’re saying so in public.

Concerned about run-away lending at the country’s banks, the China Banking Regulatory Commission, has asked them to conduct an increasingly harrowing series of stress tests to see how big an effect various economic scenarios would have on bank balance sheets and capital. In the most recent regulators asked banks to model the effects of a 60% drop in housing prices in China’s biggest cities.

No problems, the banks reported back. Even a 60% drop in housing prices wouldn’t create big bad loan problems. For example, the Bank of Communications, China’s fifth largest lender by assets, said that a 60% drop in housing prices would add just 1.2 percentage points to its non-performing loan ratio.

The reaction was hooting by analysts and investors. No one believed the numbers.

And now that no one includes Liu Mingkang, chairman of the Banking Regulatory Commission. In comments published on Wednesday, September 8, he said that China’s banks need to improve the design and implementation of stress tests, and that “the risk management system in the Chinese banking sector still has many weaknesses.”

Liu’s comments echo those in an editorial by Xiu Gang, chairman of the Bank of China. Xiu called the current expansion of China’s banks “irrational” and said that the current system, which rewards unfettered growth, “neither assures the long-term sustainable development of the banking sector nor satisfies the need for a balanced economic and social structure.”

I think the public comments are a shot across the bow of China’s banks, warning them that they need to raise capital to shore up their balance sheets as quickly as possible because capital and lending standards are going to get tougher in the not so distant future.

It’s not clear to me that the banks could raise money much faster than they are currently. Every day seems to bring notice of another share offering in Hong Kong and Shanghai. But if the management of China’s banks thought they might be able to relax after this round of capital raising is done, now they’ve been put on notice that their job is just beginning.

So far the huge amounts of capital required to fund bank offerings doesn’t seem to have put inordinate pressure on China’s pool of investment capital or its financial markets. That’s no guarantee that another wave of capital raising won’t stress the system, however. I think China’s banks are about to apply a stress test of a different sort to the entire financial system of the country.

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