IN THE war between China bulls and bears, the country's banks represent an important battleground. The banks are China's most valuable listed firms, accounting for more than a fifth of the entire Hong Kong stockmarket. Their broader significance to China's economy is enormous: they provide the bulk of the country's capital, and their results should, theoretically at least, reflect how well its businesses are performing.
Based on their expected results there is reason only to applaud. Earnings rose by 20-50% in 2010 and analysts are predicting particularly good first-quarter numbers. Profits are growing by more than 20% annually, estimates May Yan of Barclays Capital. Loan losses are vanishingly small. Lending margins are expanding. The potential for fee income is all but untapped. Demand for credit is insatiable. Alternative sources of capital are limited.
Yet the market has its doubts. Though their history as public companies is short, Chinese banks have typically traded at 2.3 times their book value and 12-13 times future earnings. At the moment, however, they trade at 1.5 times book value and eight times expected earnings, levels that ordinarily mark out firms that are vaguely troubled or face brutal competition.
There are many possible explanations for these low prices. Perhaps the best is credit risk. Losses over the past year ran at 40-50 basis points of their loan books for the large banks, a rate that is minuscule for even the most buoyant economy. Ms Yan believes losses will bump up in the coming year, but remain between 50 and 60 basis points, still extraordinarily low.
The bears concede that losses may stay that way for a while, but argue that a huge, government-ordered expansion of bank credit over the past two years in response to the crisis must eventually produce vast losses. The only question is when.
There is particular concern about loans made to entities tied to local governments and to property investors, some of which have been passed along to affiliated trust companies. Argument and counter-argument abound. No one doubts that there are lots of empty flats, but equally no one doubts that there is lots of demand. Plenty of those flats were bought with credit but loan-to-value ratios were, many bankers claim, conservative, while standards are nothing like as loose as in America. One credit officer in a Chinese bank says that far more important than any aggregate statistic is lenders' intimate knowledge of the thick, extraordinarily rich, slice of buyers who can weather a downturn.
Aware of credit-quality concerns, the Chinese banks have been steadily putting aside reserves. Optimists like Barclays Capital's Ms Yan say that even if the reserves were inadequate the central government would intervene and has the capacity to do so. It has in the past, though that was before the banks had public shares. Would they and their shareholders be spared pain again?
Another concern that hangs over the banks is the central government's moves to restrict credit and cool the economy. The first bit of this policy impedes growth in the volume of banks' assets, the second raises the prospect of borrower insolvency. But even here the debate is nuanced. It would be a surprise if the year ended without double-digit lending expansion. And because banks can reprice their assets faster than their liabilities, interest-rate tightening should push up their net interest margins in future (see chart).
A final concern is whether the banks, given their growth and possible losses, have adequate capital. Here again the debate is fierce. Almost all Chinese financial institutions meet or exceed current global standards, yet capital raising continues. The five largest banks issued securities last year and another three major banks—Minsheng Bank, CITIC and Bank of Shanghai—are expected to tap the market soon. Optimists see this as an opportunity to put money to productive use. Sceptics just sigh. If everything were really going well, they contend, then banks would be spewing out cash, not raising more of it.