One in three Chinese banks fails to create economic value, McKinsey report says

Are Chinese banks value creators or destroyers? That is the question being asked in financial circles after a report published last week by consulting firm McKinsey & Co claimed that a third of China’s lenders failed to create any economic profit last year.

Of the 40 major banks the company monitors, 13 failed to generate any economic value added (EVA), the company said in a report published on its website on Friday.

EVA is a gauge of financial performance based on the residual wealth calculated by deducting the cost of capital from operating profit, adjusted for taxes.

The 40 lenders created a combined economic profit of 333.5 billion yuan (US$50.27 billion) in 2016, down 32 per cent from the previous year, while their average risk adjusted return on capital fell to 20.4 per cent from 18.2 per cent in the year, McKinsey said, basing its calculations on data from the lenders’ financial reports.

The top three value creators were Industrial and Commercial Bank of China, China Construction Bank and Bank of China, while the worst performers were Postal Savings Bank of China, China Guangfa Bank and China Citic Bank, it said.

“Chinese banks are faced with three grey rhinos,” global senior partner Joseph Luc Ngai said in the report.

Postal Savings Bank of China was one of the worst performers based on McKinsey’s report, which said China’s banks were facing “three grey rhinos”.

“They are narrowing interest margins amid interest rate liberalisation, heavier burdens from non-performing loans and the deleveraging challenge amid stricter supervision from regulators,” he said.

“Their prospects are increasingly uncertain, and the next three years will be a watershed when the bad performers will become worse.”
China’s crackdown on grey rhinos won’t reduce its debt burden, it will only redistribute it

Despite the bleak assessment, other industry insiders said the report was produced against the pessimism of 2015 and 2016, a period that saw a marked slowdown in China’s economy, a stock market rout and a huge depreciation in the value of the yuan that sent shock waves around the world.

Since then, however, both China’s economy and its banking sector had improved significantly, according to Industrial Bank analyst Qiao Yongyuan.

“The pessimism is not in accordance with the fundamentals of Chinese banks,” he wrote in a note published on Tuesday.
“Since the end of 2016, banks have seen their interest margins improve as interest rates have been rising and the economy has been more resilient than expected.”
The average non-performing loan ratio of commercial banks on the mainland at the end of June was 1.74 per cent, unchanged from the end of last year, according to official data.

The note said also that the 15 per cent required return used in McKinsey’s model was unrealistic. A figure of 7-9 per cent was more appropriate, it said, and on that basis just one of the 40 banks monitored last year could be classed as a “value destroyer”.

Of the 25 A-share listed banks in China, 23 posted profit growth for the first three quarters of this year. Their combined net profit for the period rose 4.6 per cent from the first nine months of 2016 to 1.13 trillion yuan, or about 4.15 billion yuan a day.

Shen Jianguang, chief economist at Mizuho Securities Asia in Hong Kong, said Chinese banks made “hefty profits” for their shareholders.
“An evaluation of their profitability should recognise their twin roles as commercial lenders and policy tools,” he said.

While the McKinsey report blamed the banks’ low profits on high levels of corporate loans, Shen said such lending – much of which was to state-owned enterprises – was regarded as a safe bet. It was also considered politically correct as President Xi Jinping had emphasised the importance of a bigger and stronger state sector in the country’s economic development.

James Stent, author of China’s Banking Transformation: the Untold Story and a former independent director at Minsheng Bank and China Everbright Bank, said the country’s banks were actually “pretty healthy” after nearly two decades of steady transformation.

“Compared to money centre banks in New York, London and Frankfurt, Chinese banks lack cutting-edge products, diversity of service offerings, sophisticated treasury operations, branding and international experience. And it remains to be seen how well they will fare against robust non-bank players,” Stent wrote in the September issue of Gavekal Dragonomics’ China Economic Quarterly.

“Yet, China’s big banks substantially comply with international standards on accounting, capitalisation, provisioning and liquidity.
“They are global leaders in financial technology and consumer payments.”

The debate on the health of China’s banking sector was nothing new, Guo Tianyong, a professor at the Central University of Finance and Economics in Beijing, said.
“Chinese banks had a difficult time convincing their foreign counterparts of their value and persuading them to become strategic investors before they sought initial public offerings in 2005 and 2006,” he said.

“Those partners offloaded their shares when the 2008 global subprime debt crisis crippled their core businesses. They exited with big profits, but mainland banks escaped mostly unscathed.”
Source: South China Morning Post