It is no secret that China has used its banks like credit cards to finance an infrastructure spending spree in recent years.
So the bet for investors going long on Chinese banks has been straightforward: that, like credit card companies the world over, the lenders will rack up profits from hefty interest margins far outweighing any losses from defaults. However, reports in the past two weeks about the true debt load of local governments have exposed the inherent risk in this bet.
Could the massive Chinese "credit card" bill go unpaid, leaving banks with a pile of bad loans and depressed earnings for years to come?
As if to underline that fear, a series of prominent investors have cut their holdings of Chinese bank shares in recent days.
Temasek, the Singapore state-owned investment company, sold shares in two of China's big banks for $3.6 billion (Dh13 billion). The National Social Security Fund, which manages the Chinese pension plan, has also trimmed its bank stakes, according to state media reports.
Whether the timing was coincidental or not, the implication seemed clear enough. Some of the smartest money in China had decided the time was ripe to scale back investments in state-owned banks. However, the fact that Chinese local governments are highly indebted and banks might find themselves on the hook for some of this debt is hardly new.
When the National Audit Office said last week that local governments owed 10.7 trillion yuan (Dh6 trillion), it was authoritative confirmation of numbers that were already floating around.
When Moody's said last week that debt levels might even be 3.5 trillion yuan higher, it reinforced scepticism that was already widespread. Concerns about the toll that government debt could take on Chinese banks began to emerge in late 2009, when Beijing was beginning to wind down the large stimulus programme it used to power the economy during the global financial crisis. Banks provided the horsepower for that stimulus, unleashing a record 9.6 trillion yuan in new loans in 2009, almost double the previous year's amount.
Once investors got over the giddy high of seeing China soar back to double-digit growth while the rest of the world was mired in the most sluggish of recoveries, the realisation sank in that the bill for this success would someday come due.
That realisation has been amply reflected in the share prices of Chinese banks. Since the start of 2010, Industrial and Commercial Bank of China, the world's largest lender, has seen its shares slump by 19 per cent on the Shanghai stock exchange and 8 per cent in Hong Kong, underperforming the wider market by a huge margin.
The story has been much the same for other banks, with Bank of China down 26 per cent and China Merchants Bank down 23 per cent in Shanghai over the past 18 months.
Can they fall much further? Not likely, say many analysts. They say the market has already taken on board the full gamut of bad news, from debts to defaults and recapitalisation.
"Share prices have already priced in an unreasonably high level of pessimism," says Victor Wang, who covers Chinese banks for Macquarie in Hong Kong. With banks enjoying a 20 per cent return on equity, but trading at less than eight times estimated 2011 earnings, their shares are pricing in both a substantial slowdown in the Chinese economy and a substantial deterioration in profitability. These scenarios are "very unlikely to materialise", Wang says.
For one thing, Beijing has already taken steps to ensure banks have enough ballast for the choppy waters ahead. The country's biggest banks raised $80 billion (Dh293 billion) last year via share and bond issues to replenish depleted capital.
On top of that, the China Banking Regulatory Commission has steadily ratcheted up capital requirements. And where defaults have loomed, as in the case of a highway developer in the province of Yunnan, the government has stepped in to pick up most of the liabilities and keep banks from suffering significant losses.
But none of this means that Chinese bank shares are poised for a sustained rally. Wang says "the inconvenient truth" is that China has 6,576 financing vehicles that have been used by local governments as platforms to get around borrowing restrictions and which now house most of their debt.
If just a fraction of these vehicles have problems repaying loans, there could be scores of troubled loans hitting the headlines. Endless anecdotal cases of trouble will keep the air around Chinese banks thick with negative sentiment, despite their robust fundamentals.
From / Gulf News