In Depth: Pandemic-Era Helping Hand Comes Back to Haunt China’s Banks

The Chinese government's initiative to boost lending to small businesses during the pandemic has begun to raise alarm among Chinese banks due to increasing misappropriation of these funds, particularly exacerbated by China's persistent real estate slump [para. 1]. Nonperforming loan (NPL) ratios for personal business loans (PBLs) are increasing, highlighting banks' deficiencies in due diligence which have allowed funds intended for specific purposes to be diverted elsewhere, negatively impacting lenders' financial health [para. 2].

PBLs are generally granted to individuals such as small business owners and entrepreneurs to cover operational expenses, with repayment typically required within three to five years [para. 3]. Following the Covid-19 outbreak, Chinese banks, encouraged by the government, extended PBLs at a rapid pace to support industries like wholesale, retail, and hospitality, resulting in an unprecedented growth in outstanding loans [para. 4][para. 5]. By mid-2023, PBL accounts soared to nearly 24 trillion yuan ($3.4 trillion), doubling the figures from 2019 [para. 6]. Large and medium-sized banks played a significant role in this growth, with the "Big Six" state-owned banks issuing 57% of the nearly 12 trillion yuan disbursed by the 40 mainland-listed banks as of June 2023 [para. 7][para. 8].

However, the rise in banks’ NPL ratios is concerning. Data at the end of June 2023 showed an increase in NPL ratios among many banks, with China Construction Bank Corp. experiencing the largest rise of 0.62 percentage points to 1.57%. This is in contrast to the NPL ratio for all commercial banks in China, which decreased to 1.56% during the same timeframe [para. 9][para. 10]. Many banks are worried that their substantial volume of PBLs could spell financial trouble if the trend of bad loans continues [para. 11].

A key issue identified by bank insiders is that the ongoing real estate slump has driven up NPL ratios for PBLs. Borrowers exploited lower PBL interest rates, which were often below 4%, compared to average mortgage rates of 5.22%, and used these loans for real estate speculation, even though such use was prohibited [para. 12][para. 13]. This became problematic when, post-Evergrande's 2021 default, housing prices began falling, making it difficult for borrowers to sell properties or secure new loans to repay previous ones, leading to defaults [para. 14][para. 15]. Banks also faced issues with borrowers using PBLs to prepay mortgages at lower interest rates, further distorting the purpose of these loans [para. 19].

Efforts have been made to address these challenges, with banks tightening loan review processes and improving oversight on the utilization of PBL funds. However, misappropriation persists. Industry leaders suggest enhancing banks' capacity to monitor fund usage and propose creating an interbank coordination mechanism for transparency in fund utilization [para. 21][para. 22]. Moreover, the Central Bank's guidance for commercial banks to lower mortgage interest rates could reduce incentives for using PBLs to prepay mortgages, aiming to restore the original intent of these loans [para. 22][para. 23].