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Too Small to Fail? The Systemic Risk in China's SME Boom
SME credit continues to expand at a blistering pace. SME lending remained the fastest-growing segment of bank loan books. The latest data show outstanding SME loans approaching RMB82 trillion, accounting for over 60% of GDP, much higher than the pre-Covid level of 37% of GDP in 2019. This makes SME loans materially larger than both real estate developer and LGFV loans combined.
Loan pricing has collapsed. Average SME loan rates have fallen further, with many banks now offering SME loans rates that are oftentimes below that of mortgage loans. What was once the highest-risk, highest yield segment in bank portfolios is now priced as if is the among the lowest risk.
The recognition moratorium is now formal policy. We previously speculated that the SME bad loan recognition moratorium was still in effect after it expired in 2023. However, the March 2024 Government Work Report confirmed that speculation and explicitly reiterated that it is, indeed, still in effect. This mandates that banks are expected to maintain loan rollovers and refrain from downgrading troubled SME credit. In effect, an "extend and pretend" approach has been codified.
Lessons from around the region suggests this will end badly. The sharp deterioration in asset quality in other Asian countries following the abrupt end of their respective Covid loan moratoriums is telling. Many countries saw a surge in NPL formation once protections were lifted (mostly in 2022). China's moratorium, now in its fifth year, is longer and larger than that of any other country. The longer it lasts, the greater the underlying risk is going to be.
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