This document summarizes a report on credit risk in China's banking sector. It identifies trends in credit risk, characteristics of Chinese bank credit risk, and regulations. It finds that total loan balances and non-performing loan ratios in Chinese banks are increasing, indicating greater credit risk. Credit risk is concentrated in state-owned banks and certain industries. It recommends that Chinese banks improve credit risk management by implementing advanced internal credit rating systems, expanding the use of credit derivatives, and strengthening credit risk culture.

1. Credit Risk in China’s Banking
Sector
Prepared by Fay Zhou
Aug 7th, 2013

2. A look at our report methodology and purpose
• Findings based on
• Secondary research - internal knowledge, government,
vendor and financial institutions’ reports.
• Report purpose:
• Identify the current trends of credit risk in Chinese banks
• Define the characteristics of credit risk in Chinese banks
• Understand Chinese credit risk regulation
• Provide Recommendations for banks to improve credit risk
management
2

3. Section 1: Chinese Bank Credit Risk Overview
Section 2: Characteristics of Credit Risk in Chinese
Banks
Section 3: Credit Risk Management Regulations
Section 4: Recommendation to Reduce Credit Risk

4. Overview - Credit Risk in China’s Banking Sector
4
44.5
46.6
48.5 50.2 51.7
54.62
16.20%
15.70%
15.90%
16.70%
16.10%
17.30%
14.50%
15.00%
15.50%
16.00%
16.50%
17.00%
17.50%
0
10
20
30
40
50
60
2011-Q4 2012-Q1 2012-Q2 2012-Q3 2012-Q4 2013-Q1
GrowthRate
TotalLoanBalance(TrillionYuan)
Loan Balance in Chinese Banks, Trillion Yuan
Total Loan Balance Growth Rate (Y-O-Y)
Source: CBRC, 2013
• Chinese banks highly rely on loan business for profits
• Credit Risk - the most important risk in Chinese banks
• Increase on loan balance => potential credit risk

5. Overview - Credit Risk in China’s Banking Sector
5
• Upward trend on NPL Ratio from 2012 => Higher risk to
receive loan repayment
• Rural commercial banks have highest NPL ratio
427.9 438.2 456.4
478.8 492.9
526.50.96%
0.94% 0.94%
0.95%
0.95%
0.96%
0.93%
0.94%
0.94%
0.95%
0.95%
0.96%
0.96%
0.97%
0.0
100.0
200.0
300.0
400.0
500.0
600.0
2011-Q4 2012-Q1 2012-Q2 2012-Q3 2012-Q4 2013-Q1
NPLRatio
NPLBalance
Chinese Bank Non-Performing Loan Ratio
NPL Balance NPL Ratio
Source: CBRC, 2013

6. Overview - Credit Risk in China’s Banking Sector
6
• Provision coverage ratio - the ability that bank possessed
against non-performing
• Increased provision coverage ratio => enhanced risk
absorbing capability
Source: CBRC, 2013
41.40%
116.60%
153.20%
217.70%
278.10%
295.50% 292.00%
0.00%
50.00%
100.00%
150.00%
200.00%
250.00%
300.00%
350.00%
2007 2008 2009 2010 2011 2012 2013-Q1
Provision Coverage Ratio

7. Overview - Credit Risk in China’s Banking Sector
7
• Capital adequacy ratio – held capital to meet potential
credit, operational, and market risks
• Risk resilience is the ability to control and manage credit
risk
Source: CBRC, 2013
8.40%
12%
11.40%
12.20%
12.71%
13.30%
12.28%
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
2007 2008 2009 2010 2011 2012 2013-Q1
Capital Adequacy Ratio in Chinese Banks

8. Overview - Expenditure on Credit Risk Management
8
• Forecasted IT spending on credit risk management
system (thousand Yuan)
Source: IDC, 2012
2012 2013e 2014e 2015e 2016e
Storage 1108.2 1363.1 1676.6 2062.3 2536.6
Server 779.3 944.5 1144.8 1387.5 1681.6
Network 347 412 490 582 691
Infrastructure
Software
194 232 276 329 392
Application Software 355 438 540 666 821
Application Service 445 561 708 893 1126

9. Section 1: Chinese Bank Credit Risk Overview
Section 2: Characteristics of Credit Risk in Chinese
Banks
Section 3: Credit Risk Management Regulations
Section 4: Recommendation to Reduce Credit Risk

10. Characteristics of Credit Risk in Chinese Bank
• Concentrated Credit Risk in State-owned Banks and in certain
industries
• Concentrated credit risk in certain industry
10
Source: CBRC, 2012
0.00% 5.00% 10.00% 15.00% 20.00% 25.00% 30.00% 35.00% 40.00% 45.00% 50.00%
State-owned Bank
Joint-stock Bank
Rural Financial Institutions and Postal Saving Bank
47.30%
16.20%
15.20%
BANK MARKET SHARE (BASED ON ASSET)

11. Characteristics of Credit Risk in Chinese Bank
• Increasing Shadow Banking System
Ø Shadow banks- financial intermediaries are not subject to
regulatory oversight
Ø Size: 22.9 Trillion Yuan (US$3.7 Trillion) ->Increased credit risk
• Non-strict Loan Investigation
Ø Unqualified lending – 24.57 Billion Yuan
Ø Potential credit risk from unqualified project and firm
11

12. Section 1: Chinese Bank Credit Risk Overview
Section 2: Characteristics of Credit Risk in Chinese
Banks
Section 3: Credit Risk Management Regulations
Section 4: Recommendation to Reduce Credit Risk

13. Current Chinese Credit Risk Management Guidelines
13
• Guidelines for the Supervision of the Internal Rating System for
Credit Risk of Commercial Banks
o Purpose – improve credit risk management ability by
establishing an independent and internal credit rating
department
State-owned
Bank
Cooperative Institution
Result
ICBC
PwC
Internal Rating System
Customer Rating
Debt Credit Rating
PD and LGD Measurement
Non-retail Credit Rating
BOC
McKinsey
PD Model
Credit Information System
BOC (Hong
Kong)
Hong Kong Monetary
Authority
S&P
Internal Rating System
Default Filter
CCB
-
Corporate Credit Risk Rating Warning
System
Internal Rating System
BOComm
Oliver Wyman
Internal Rating System
ABC
Experian
Internal Rating System

14. Current Chinese Credit Risk Management Guidelines
14
• Guidelines on the Measurement of Regulatory Capital of
Specialized Loans of Commercial Banks
o Purpose – better regulation of specialized loans
• Guidelines for the Measurement of Regulatory Capital for
Credit Risk Mitigation in Commercial Banks
o Purpose – define the features, evaluation method, management
process, corresponding information system of credit risk
mitigation

15. Section 1: Chinese Bank Credit Risk Overview
Section 2: Characteristics of Credit Risk in Chinese
Banks
Section 3: Credit Risk Management Regulations
Section 4: Recommendation to Reduce Credit Risk

16. Mitigating Credit Risk in Chinese Banks
16
• Credit Rating System
Ø Independent internal and external credit rating system
Ø Data collection on loss given default (LGD), and probability of
default (PD)
Ø Conduct standard on data quality to enforce the accuracy and
comprehensiveness of business data
Ø Implement advanced credit risk measurement model and
internal rating system

17. Mitigating Credit Risk in Chinese Banks – Collateral
17
Types of Collateral
Collateral Eligibility
Collateral Management
Cash
Fix-Income Securities
Bank Guarantees
Equities
Real Estate
Convertible Bonds
Commodities
Liquidity
Easy to settle
Default Free
Recognized Collateral
Type
Collateral Valuation
Margin calls
Liquidity Risk Monitoring
Market Risk Monitoring
Cross-pledged Relations
Monitoring
Substitution
Advantages: Reduce
credit risk,
Diversification,
Improve liquidity,
Higher profits
Disadvantages:
Operational risk,
Market risk, Legal
risk, Settlement risk,
Valuation risk

18. Mitigating Credit Risk in Chinese Banks
18
• Application of Credit Derivatives
Ø Separate and transfer the credit risk of an asset from one
counterparty to another
Ø Reduced credit risk concentration
Ø Facilitate credit derivative innovation => improving
comprehensive management
Ø Strengthen CDs supervision
• Credit Environment and Culture
Ø Eliminate improper operation on loan credit rating and loan
granting

19. For more information about the topics covered in this webinar or Kapronasia, please visit
www.kapronasia.com or send us an email: research@kapronasia.com. Twitter: @chinafintech
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