China’s financial regulator asked banks to respond to a bearish research report on China's banking sector issued by Goldman Sachs Group last week, which sent shares of the country’s biggest banks tumbling down.
The report downgraded ratings on several Chinese banks, such as Agricultural Bank of China, Industrial and Commercial Bank of China (ICBC), and Industrial Bank, highlighting risks of lenders’ exposure to local government debt that could lead to losses, weakening earnings growth, and affect dividend payout levels. The report estimates that China’s banking system holds about 94 trillion yuan of local government debt, with smaller lenders, which account for less than half of banking assets, bearing an outsized 59 trillion yuan exposure.
A prolonged downturn in China’s property sector put a squeeze on China's largest banks which now face near-term revenue and margin pressures due to rising costs and a deteriorating global economy. According to estimates from the International Monetary Fund, last year, borrowings from Chinese local government financing vehicles, off-balance-sheet entities municipalities use to finance their expenditure, ballooned to 57 trillion yuan ($7.9 trillion), or 48% of China’s gross domestic product.
China Merchants Bank Co. wrote a rebuttal published by Bloomberg, stating that Goldman’s assumptions have “misled some investors and caused them to worry about the asset quality.” Shanghai Banxia Investment Management Center also dismissed the report, saying “The US bank’s prediction that China’s local government debts would sink Chinese banks’ profits and push up their bad loans will likely be proven wrong”.
Goldman’s report comes amidst escalating investors’ concerns over the health of China’s debt-ridden local-government financing vehicles. Worries that banks may incur losses from these debts started rippling through financial markets.