China Tells Banks to Stress Test for 60% Home-Price Drop

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China Tells Banks to Stress Test for 60% Home-Price Drop

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By Bloomberg News - Aug 4, 2010 11:32 PM GMT+0800 Wed Aug 04 15:32:00 UTC 2010

China’s banking regulator told lenders last month to conduct a new round of stress tests to gauge the impact of residential property prices falling as much as 60 percent in the hardest-hit markets, a person with knowledge of the matter said.

Banks were instructed to include worst-case scenarios of prices dropping 50 percent to 60 percent in cities where they have risen excessively, the person said, declining to be identified because the regulator’s requirement hasn’t been publicly announced. Previous stress tests carried out in the past year assumed home-price declines of as much as 30 percent.

The tougher assumption may underscore concern that last year’s record $1.4 trillion of new loans fueled a property bubble that could lead to a surge in delinquent debts. Regulators have tightened real-estate lending and cracked down on speculation since mid-April, after residential real estate prices soared 68 percent in the first quarter from a year earlier, according to estimates from Knight Frank LLP, the London-based property adviser.

A deep slump in China’s property market may further slow the nation’s economy, which grew at a less-than-forecast 10.3 percent pace in the second quarter. China is still the fastest growing major world economy. Concern that Chinese growth may slow due to a real-estate slump erased an early rally in U.S. stocks.

Non-Performing Loans

The China Banking Regulatory Commission said in a July 20 statement that banks should “continue to deepen” stress tests on lending to property and related industries, citing a speech by Chairman Liu Mingkang during a meeting attended by regulatory officials and bank heads. The release didn’t give details. Officials at CBRC didn’t return calls seeking comment.

Results from previous stress tests show that the ratio of non-performing real estate loans among Chinese banks would rise by 2.2 percentage points if home prices drop 30 percent and interest rates rise by 108 basis points, the person said. Pretax profits would fall 20 percent under that scenario. A basis point is 0.01 percentage point.

Measures to cool property-price gains included raising minimum mortgage rates and down-payment ratios for second-home purchases, and a suspension of lending for third homes.

Property Slowdown

Property prices in 70 Chinese cities dropped 0.1 percent in June from the previous month, the statistics bureau said July 12. Prices rose 11.4 percent from a year earlier, the second monthly slowdown after April’s record expansion.

Bank of China Ltd.’s bad-loan ratio would climb 1.2 percentage points under the worst-case scenario drawn up in the latest stress tests, Li Lihui, president of the nation’s third- biggest lender by market value, said May 27.

Record lending last year in China and the ensuing surge in home prices have stoked concerns that a bubble is forming that may threaten the banking industry. Property stocks are the worst performers on the Shanghai Composite Index this year with an average 21 percent drop, data compiled by Bloomberg show.

“There is a perception in the real-estate development community that banks and the market cannot tolerate much more than a 25 to 30 percent drop in prices,” said Nicholas Consonery, an Asia specialist at Eurasia Group in Washington.

Still, the government probably doesn’t expect prices to drop by 60 percent, Consonery said in a phone interview. It’s seeking to “signal to the market that banks are sound even with a significant drop in prices,” he said.

Rogoff’s Warning

China’s property market is beginning a “collapse” that will hit the nation’s banking system, Kenneth Rogoff, a Harvard University professor and former chief economist of the International Monetary Fund, said July 6.

Average prices may fall as much as 20 percent over the next 12 to 18 months, with declines of up to 40 percent in “big bubble” cities, Nomura Holdings Inc. said in a July 2 report. The impact on banks’ asset quality will still be “limited” as long as borrowers have adequate income to keep paying their mortgages, Nomura said.

The banking regulator has reminded lenders that some developers with high debt burdens and large land reserves already face the risk of a funding collapse, the person said. Banks were told to gauge developers’ real borrowing needs by monitoring the progress of projects under construction and to “strictly” control the pace of lending, the person said.

“Special mention” real-estate development loans have climbed in Shanghai since April and rose by 1.4 billion yuan ($207 million) in June, Xinhua News Agency reported Aug. 1, without saying where it got the information.