China banks build big reserves for losses, but will it be enough?

China’s banks have been putting aside more money to prepare for rising losses from loans to local governments. According to a recent report by China Construction Bank, mainland lenders have

already put aside double their expected non-performing loans (NPLs) as reserves. Pedestrians walk past a branch of the Industrial and Commercial Bank of China (ICBC) in central Beijing. Teh

Eng Koon |AFP | Getty Images But whether this money is enough is in dispute. Paul Schulte, Global Head of Financial Strategy and Banks Research at China Construction Bank argues that banks

have squirreled away enough money to protect them from the billions in losses they are likely to see in the coming years. For example, Industrial and Commercial Bank of China (ICBC) has put

aside $25.9 billion in its reserves, while Agricultural Bank of China (Agbank) has put aside $26.2 billion, according to CCB research. But one academic believes that even these lofty amounts

won’t be enough. “The NPLs currently recognized by the banks are way too low to be seen as a realistic estimate of the kind of losses they are likely facing from the latest wave of

lending,” says Patrick Chovanec, associate professor at Tsinghua University. Chovanec argues that Chinese banks have extremely low reported NPL ratios and the amounts put aside will cover

the bad loans they’ve recognized but not the NPLs that are yet to come. “It's no coincidence that last year Chinese bank regulators instructed a whole host of banks to go out and raise

more capital, ” he noted. No one disagrees that big losses are coming. In fact, last year, local banks were forced to ramp up their reserves as the China Banking Regulatory Commission (CBRC)

anticipated losses from the lending boom that took place following the global financial crisis. CCB International estimates that 20 percent of the $1.6 trillion in municipal and provincial

debt outstanding, will be unrecoverable. In that “worst-case scenario” Chinese banks will face $330 billion in losses. CCB argues that even if the government doesn’t share in these losses,

if all the reserves are already used up, and if none of these bad debts have been securitized (i.e. sold to other investors), Chinese lenders will face a capital shortfall of $17 billion for

2011, and around the same amount in 2012. “We want to make the point that if we take the worst-case scenario and fully write-off the loans, we are still not walking into Armageddon,” he

added. CCB’s Schulte says ICBC, Agbank and Chongqing Rural Commercial Bank (CRCB) are the best positioned because of their high reserves. However, he warns that smaller lenders including

CITIC Bank and Bank of Communications are at a disadvantage in terms of liquidity and will need the most capital when the losses come due.