China’s banking sector is an important feature of the country’s financial system that has contributed to its position as the second largest economy in the world. Currently, China’s banking sector is under pressure due to rapid credit growth that has occurred in the last few decades (Wei and Inman par. 2). Banks have made it easy for state enterprises, businesses, borrowers, and local governments to acquire loans.
This has led to accumulation of bad loans that are threatening to destabilise the country’s economy. Financial experts have projected a rise in bad loans and a consequent decline in earnings growth that will financial risks in the banking industry (Wei and Inman par. 3).
The high number of borrowers who are unable to pay their loans has affected the country’s financial system adversely. The banks are currently implementing different strategies and mitigation measures that are aimed at strengthening their balance sheets in preparation for slow economic growth.
Raising capital is not a viable option for the banks because many investors have sold their stocks in these banks due to unfavourable financial outcomes and slow economic growth. The uncertainty in the financial markets has worsened the situation. The main cause of the problem is the use of poor financial strategies by banks in efforts to circumvent lending limits imposed by the government. Many banks have increased their off-balance-sheet loans in order to grow their earnings and capital (Wei and Inman par. 4).
However, this has affected their financial stability because it has increased the number of high-risk borrowers and debt. These unofficial financial transactions are collectively known as shadow banking. In June 2013, the Central Bank of China allowed interbank borrowing in order to mitigate the negative effects of shadow banking (Wei and Inman par. 7).
This move initiated a rise in borrowing costs among banks that caused frenzy in the country’s financial system because it threatened the stability of equity and bond markets. Many banks are pursuing different avenues to raise their capital bases.
For example, in 2013, Agricultural Bank of China, Industrial & Commercial Bank of China Ltd, Bank of China Ltd, and China Construction Bank Corporation sought an approval from the government in order to issue securities worth $44.1 billion to investors as a way of raising capital (Wei and Inman par. 9).
Financial analysts have criticised that move because of the state of China’s financial system. Even though China has the second largest economy in the world, it is founded on a shaky financial system. The growth of the country’s biggest banks in terms of market capitalisation has been fueled by shadow banking.
The greatest challenges facing China’s banking system are high-risk loans issued to local governments and off-balance-sheet lending. Local governments have high debts that could morph into bad loans because many of them have reported decreased revenues in the past few years (Wei and Inman par. 10). In order to lessen their financial risks, many banks are extending the maturity periods of loans held by local governments.
They are implementing mitigation strategies that have the potential to lower financial risks. China’s banking sector is not as healthy as the government depicts it to be. Slow economic growth and innumerable bad loans are threatening the stability of the banking industry. It is important for the government to assist banks financially.
Another challenge is rapid growth of banks that is not in line with their earnings. Many banks’ capital bases are not sufficient to sustain their rapid growth rates. According to the China Banking Association, many banks will experience significant decline in revenue due to bad loans and numerous nonperforming assets (Wei and Inman par. 12). Banks need to either raise more capital or give up their expansion programs.
Works Cited
Wei, Lingling, and Inman Daniel. Chinese Banks Feel Strains after Long Credit Binge: Rapid Loan Growth Has Led to Serious Debt Problems at Local Governments. 2013. Web.