Tough road ahead for banks, S&P warns

China's top 50 banks ranked by total assets will face growing strain on profitability and have their resilience tested in the next three to five years as operating conditions turn harsher, a global rating agency said in a study Wednesday.

Underestimated credit risks for many State-owned corporate clients encouraged strong demand for loans and lavish credit allocation to uneconomical projects, Standard & Poor's said.

S&P noted that China's huge stimulus package following the global financial crisis has constrained the banks' ability to manage risk because the banking sector served as the government's chief tool in this fiscal and monetary stimulus. And it also predicted that the damage to their balance sheets is about to surface as China's economic growth slows down.

"The banks' operating conditions are getting harder since the country's fast growth cycle has ended," Huang Can, rating director of Financial Institution Rating at China Cheng Xin, Moody's Chinese affiliate, told the Global Times Wednesday.

"The banks used to be a bit impulsive on lending, especially for some government-supported projects following the stimulus package," Huang said, warning of the accumulated risks from local government financing vehicles and lending to small and medium-sized enterprises.

Earlier this year the China Banking Regulatory Commission permitted Chinese banks to effectively postpone the recognition of losses on some local government loans, which is "likely to provide short-term relief for the sector but longer-term disadvantages," Liao Qiang, director of financial institution ratings at S&P, said at a conference Wednesday.

Some financial agencies, including the China International Capital Corporation, predicted China's listed banks will see a profit growth rate of 17 percent for the first three quarters year-on-year, lower than the rate of 18 percent in the first half.

And Huang said profit decline is within her expectations because of narrowing interest margins, which hit a historical high last year.

Two interest rate cuts that took place this year could slice the banks' profitability, and the "banking sector's return on assets in 2013 will be weakened by around 20 basis points," Liao said.

The margin will be squeezed by the likely reform of market-driven interest rates promoted by the banking regulatory authority, including relaxation of the lending rate and deposit rate ceiling, according to Liao.

Before the reform, China's banks could make a profit by relying on the officially set relatively higher lending and lower deposit interest rates.

Banks may also face massive consolidation as the gap between China's strongest and weakest banks is becoming increasingly pronounced, S&P said.