Credit losses may hit $3 trillion, bank says

Goldman Sachs report warns of 'shadow banking' risk elements

China might face credit losses of up to 18.6 trillion yuan ($3 trillion), because the speed of its credit expansion has exceeded that seen prior to other credit crises in history, Goldman Sachs Group Inc has warned.

In a report dated Aug 5, it said the rapid pace of China's credit expansion, increasingly sourced from the inherently more risky and less transparent "shadow banking" sector, has become a top concern for global markets.

"Our Asian economists and strategists recently published a comprehensive look at this concern and its implications for economic growth and asset performance in China, calculating that an extreme upper-bound for total China credit losses could amount to 18.6 trillion yuan," the report said.

But actual credit losses are likely to be significantly lower than these worst-case figures, emerge gradually and be partially absorbed by bank earnings or other avenues, it added.

"There is ample room on the sovereign balance sheet to provide support, if required," the report said.

It said commodity demand and prices, emerging market economic growth and asset performance would be most at risk from any fallout from China, while some United States assets, especially US domestic-facing equities, rates and the dollar could potentially rise.

Helen Zhu, Goldman Sachs' chief China equity strategist, said parts of the corporate sector are the greatest source of credit risk, especially sectors with excess capacity, along with local government financing, while the unintended consequences of intentional policy tightening could cause things to go bad.

The impact on economic growth and asset performance will depend highly on government actions, she said, because the more proactive the nation is in tackling reforms, the more negative are the implications for near-term growth and asset returns - but the more positive over the medium term.

Figures from Fitch Ratings show that the credit-to-GDP ratio of China was close to 200 percent at the end of 2012, up by 70 percentage points in four years.

Charlene Chu, a senior director in the financial institutions group at Fitch, said that by the end of this year, banking sector assets will have increased about $14 trillion from the end of 2008, amounting to the entire US commercial banking sector.

Total social financing of the world's second-largest economy in the first half exceeded 10 trillion yuan, up more than 30 percent year-on-year, according to central bank figures.

Louis Kuijs, chief China economist at the Royal Bank of Scotland Group, said a systemic financial crisis - one that overwhelms the economy and the financial system - is less likely in China, although overall lending as a percentage of GDP is rather high for a country of China's level of development.

A Standard & Poor's Ratings Services report said a systemic threat to China posed by rapid expansion of shadow-banking activities may be several years away, if it emerges at all.

"We believe major Chinese banks' capitalization, earnings and liquidity profiles provide a comfortable buffer to absorb any possible hit from shadow banking and credit risks in the Chinese economy," said S&P's credit analyst Ryan Tsang.