The bank has put seven of the largest Chinese banks under the spotlight to examine the state of their balance sheets as the economic and market news in the Asian country has gone sour.

Investors mindful that China might suffer a hard economic landing should focus on holding the larger banks in the country because they are more attractively priced on most ways of measuring value, Coutts said in a commentary that noted that loan asset quality has fallen so far this year.

Two weeks after major Chinese banks reported an aggregate first half net profit that was up by 1.6 per cent on the same period last year, the market is now focused on asset quality, which has declined across the sector, Kieran Calder, head of equities, Asia, at the bank, said in a note yesterday.

Declining asset quality is a normal issue to be concerned about at this stage in the economic cycle, he added.

Calder ponders the plight of seven Chinese banks: ICBC; CCB; Bank of China; Agricultural Bank of China; China Merchants Bank; Bank of Communications, and China Minsheng Banking. These banks account for 39.8 per cent of the China H-share index and 15.2 per cent of the HK Hang Seng index. The A-share equivalents of these banks cumulatively make up 14.9 per cent of the China A-share index.

Analysis of the numbers shows Chinese banks falling into two distinct camps: the largest three with strong balance sheets and moderate growth; and the smaller Chinese banks with weaker balance sheets that are chasing stronger growth. The second group, Coutts said, is falling behind versus the 2018 Basel III capital adequacy target of 11.5 per cent core equity tier 1 capital.

“Simple average non-performing loan ratio increased by 24 basis points in the first half of 2015 compared to December 2014,” the report said.

The report also notes that “simple average return on assets” fell by 12 bps from a year ago in the first half of 2015, with the biggest drop at China Minsheng and ABC.

Against such a backdrop, Calder said that after falling by an average of 16 per cent this year, shares in many Chinese banks “look cheap”. On a sectoral average, banks have a price/earnings ratio of 4.8 times earnings in 2015, falling to 4.6 times earnings next year. 

“We previously expected that the biggest risk to further downside for China equity markets would be if market participants completely lost confidence in the ability of the Chinese authorities to put a floor under the market. For the banks specifically, the biggest risk to balance sheets would be if a sharper-than-expected decline in economic growth translated to higher non-performing loans, in turn putting pressure on capital ratios. This is the hard landing scenario,” Calder added.