Testing times for banks

With the world's second largest economy bidding farewell to its decades of roaring double-digit growth, it is only natural that Chinese banks will find it increasingly difficult to make big profits just by lending more.

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Chinese policymakers should keep a close eye on the possible effects of sluggish loan growth on both commercial lenders and the national economy.

And, rather than rushing to turn on the liquidity tap, policymakers should urge domestic banks to face up to this test and adapt themselves to the ongoing transformation of the country's growth pattern.

Latest figures from the People's Bank of China show the country's new yuan-denominated loans totaled 681.8 billion yuan ($108.2 billion) in April, down 61.2 billion yuan compared with a year earlier.

Such a surprising drop in new loans has understandably sparked worries among international investors that China's economic slowdown might be more serious than expected.

With the fragile global recovery still deeply uncertain due to the ongoing eurozone crisis and growing US political paralysis, the latest sign of cooling in China, a key growth engine for the world economy, does make a case for more caution.

In response to the economic deceleration, China's central bank cut the reserve requirement ratio for banks last Saturday, the third such reduction in six months.

Clearly, Chinese policymakers have recognized the urgency of fine-tuning monetary policy to accommodate slower economic growth, a price that the country has to pay while shifting the economy away from excessive reliance on exports and investment toward domestic consumption.

But Chinese banks have found that the shrinking appetite for loans has not only threatened their profit margins but also raised questions about the quality of their assets.

Just a few months ago, Chinese banks were widely criticized for the huge profits they made from a lending binge last year, though their less-mentioned overall return on assets remained razor-thin.

Now, the drop in bank lending has forced many of them into such a tight corner that some people have even suggested interest rate cuts to spur borrowing.

Should Chinese banks expect business as usual and another lending boom to stimulate growth of the real economy, which would prolong their days of easy profits?

The answer is definitely no because the country cannot afford to postpone its economic transformation and Chinese banks cannot continue to drag feet over their own reforms.

Chinese banks must improve their risk assessment capabilities and adjust their service structure to serve the country's economic transformation and justify the profit they make.

This is the test they have to take.

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