Morgan Stanley Is Bullish on China Banks After Stress Test

(Bloomberg) -- China’s broad push to corral risks has put its financial system in the position to withstand even an economic slowdown to about half the pace of the current expansion.

That’s the conclusion of Morgan Stanley after the U.S. bank conducted its own stress tests on China’s vast banking industry, which is struggling with a surge in bad debt amid the slowest economic growth in three decades.

Chinese authorities are partly to blame for the slowdown after they launched a crackdown on shadow banking to rein in financial risk, cutting off a key source of financing for many private businesses. They roiled the market last year by engineering the first bank seizure in two decades and have also bailed out two other lenders.

At the start of this year, China Banking and Insurance Regulatory Commission outlined a series of measures including carving out bad loans, setting up a resolution fund, as well as promoting mergers, capital injections and the restructuring of high risk institutions.

Morgan Stanley’s stress test showed that with economic growth as slow as 3% non-performing loans would grow at a clip of 2% a year, or 3 trillion yuan. But the financial system would still be able to keep up credit growth at 7% even factoring in a lower net interest margin for banks, the bank said in a Jan. 9 report by analysts led by Richard Xu.

“China’s financial cleanup has reduced tail risks, with a complete system to manage financial risks having been formed, tested and matured,” analysts wrote in a report. “Our own stress test shows the financial system is ready to withstand greater economic volatility, which provides more room for structural reforms.”

Chinese lenders have an “ample” 180% coverage ratio on non-performing loans, given them room to digest a growth in bad debt while maintaining a return on equity of close to 10%, they said.

Banks with high coverage on bad debt, such as Postal Savings Bank of China Co., Ltd, China Merchants Bank Co. and China Construction Bank, will have more stable profit growth than peers facing headwinds, according to Morgan Stanley. Postal Bank rose as much as 1.5% in Hong Kong while Construction Bank gained 0.6% as of 3:18 p.m.

The U.S. bank highlighted moves by the authorities that have reduced leverage, duration mismatches and increased financial transparency as key to easing risks. The seizure and bailouts have “tested processes” to manage risks and a 50% cut in peer-to-peer lending has built confidence, according to the report.

“In addition, we still expect ample policy reserves should there be a rapid GDP slowdown,” the bank said.

Morgan Stanley upgraded its view on the sector to “attractive” from “in-line.”

To contact Bloomberg News staff for this story: Evelyn Yu in Shanghai at yyu263@bloomberg.net

To contact the editors responsible for this story: Candice Zachariahs at czachariahs2@bloomberg.net, Jonas Bergman, Jun Luo

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With assistance from Bloomberg