Chinese Banks are Most Vulnerable to Distress in the Real Estate, Transportation, and Mining Sectors, Study Finds

Title:  Research on Risk Spillover Effects between Industries and the Banking Industry from the Perspective of Systemic Risk Management (系统性风险管理视角下实体行业与银行业间风险溢出效应研究)
Journal: Studies of International Finance (国际金融研究)
Author: Zhai Yonghui (翟永会) 
Publication Date: December 2019

  • Using a model developed by economists at Princeton and the Federal Reserve, economist Zhai Yonghui measures levels of interdependence between different sectors of China’s economy and the Chinese banking system. Zhai notes that financial crises often begin with failures in the “real economy” and then spill over to banks.

  • Based on her analysis, which used daily financial index data from 24 industries between 2005 to 2018, Zhai notes that China’s banking system is most vulnerable to distress in the real estate, transportation, mining, steel, and chemical sectors. A serious downtown in the real-estate sector would put as much as 5.33 percent of the banking sector’s value at risk (VaR), according to Zhai’s analysis.  (See her paper for a sector-by-sector analysis and associated charts.)

  • Zhai comments that it is not surprising that the real-estate sector poses the biggest risk for Chinese banks. At the end of December 2018, China’s real-estate loan balance was 38.7 trillion yuan, a 20 percent year-on-year increase over December 2017, and accounted for 28.3 percent of all bank lending. As housing prices have increased in recent years, so too have real-estate loan values. If housing prices suddenly fell, the ratio of non-performing loans would increase, and this would have serious impacts on China’s banking sector, Zhai writes.

  • In the transportation sector, Zhai notes that banks have lent significant numbers of short- and medium-term loans to pay for long-term transportation investments. The mismatches between debt and asset maturity dates create significant banking risks.

  • In the mining, steel, and chemical sectors, these capital-intensive industries have low liquidity and long turnover time and are very susceptible to external shocks, Zhai writes.

  • Similarly, Zhai notes that a crisis in the banking sector would spill over to industries that are highly dependent on financing. According to Zhai’s analysis, the real estate, steel, and non-ferrous metals sectors are most vulnerable to a banking crisis.

  • As policymakers consider reforms to deleverage China’s banks, Zhai argues these policies should be implemented carefully, given high interdependence between banks and major industries.

Note: The Bank of China and the China International Capital Corporation co-publish the journal Studies on International Finance. Zhai is a professor at the Henan Normal University School of Business.