Strong bank earnings conceal gloomy outlook

Official data published on Monday show that commercial banks’ non-performing loan (NPL) ratio held steady at 1.74% in Q2 and that their net profits grew almost 12% y/y, the fastest pace since 2014. That said, we think it would be a mistake to conclude that the underlying health of commercial banks has improved. Profits are up because banks have expanded their balance sheets aggressively during the past year, not because their margins have improved. In fact, banks’ return on assets has continued to slide recently, despite a stronger economy. Meanwhile, the NPL ratio almost certainly understates the true level of bad loans. And even on the official figures NPLs have continued to pile up, with the NPL ratio only stable due to the rapid issuance of new loans. With little evidence that credit allocation has improved, we think that the recent growth in bank balance sheets, while boosting profits in the short-run, is storing up greater problems for the future.