Moody's Investors Service says that the outlook for China's banking system is stable, as it has been since March 2011, reflecting Moody's assessment that the overall performance of the country's banks will remain in line with their rating levels in the next 12-18 months.
"Our stable outlook is further underpinned by our view that China will stay on a path of steady expansion and pursue an agenda of orderly reform; and we also note the pro-market announcements which have followed the Third Plenum of the Communist Party leadership in mid-November," says Christine Kuo, a Moody's Vice President and Senior Credit Officer.
In terms of challenges for the banks, the Moody's report notes several pressure points that will mostly likely be reflected in their asset quality and profitability.
Moody's notes these challenges will come from: economic rebalancing, rising financial leverage, increasing interest rate liberalisation, a greater shift towards higher-risk loan segments, and continued large fluctuations in deposit flows.
Nonetheless, despite Moody's expectation of lingering asset quality pressure, the report notes that the banks have strong loss-absorbing cushions, in the form of provisions and earnings, as buffers against the potential rise in credit costs.
And despite a likely worsening in the banks' asset quality and profitability in 2014, Moody's does not expect their credit metrics to deteriorate to a level that will negatively affect their current ratings.
Moody's says the ratings should be supported by: economic growth stabilising at an annualised rate of 7%-8% in 2014-15, based on Moody's central scenario, and actions by national and local government to mitigate the effects of new non-performing loan (NPL) formation, despite evidence of the weak standalone debt-servicing ability of many local government financing vehicles and some state-owned enterprises.
The report says that the banks are likely to face a more challenging regulatory environment in the coming 12-18 months, with financial authorities increasingly focused on reforming the financial system, using particular tools, such as interest rate liberalisation and possibly deposit insurance to set the stage for a more competitive banking environment.
Moody's also sees the potential for the authorities to put in place during the outlook horizon more components of China's bank resolution regime, including the introduction of a deposit insurance scheme and a bankruptcy law for financial institutions. Nonetheless, Moody's believes that systemic support to larger banks will remain strong, as maintaining financial stability remains a top policy priority.