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In the world of capitalism, banks play an essential role to keep the economy humming along. As such, having healthy and stable banks is essential for any economy.
With this in mind, let’s take a quick look at China Construction Bank Corp (SEHK: 939), or CCB, using the two metrics – loan-to-deposit ratio and non-performing loans, which were discussed in my previous article here, to see how much risk a bank is taking on.
1. Loan-to-deposit ratio
CCB’s had loans amounting to RMB 14,087 billion (US$2.03 trillion) and deposits of RMB 18,214 billion resulting in a loan-to-deposit ratio of 77.3% as of the end of June 2019. This was a slight improvement compared to the end of 2018 when CCB’s loan-to-deposit ratio stood at 78.1% with RMB 13,365 billion in loans and RMB 17,108 billion in deposits.
Analysing the loan-to-deposit ratio indicates to investors the amount of risk a bank is taking on. To understand this in a simple way, every loan given out by the bank carries a chance of default, meaning the borrower might not be able to return the money. If this should happen, the bank might lose the amount loaned out or get only a fraction back.
However, despite this risk, the bank is still liable to its customers for their deposits. What this means is that banks need to be prudent when giving out loans to ensure that they have a high probability of getting the money back.
2. Non-performing loans ratio
The second indicator is the non-performing loans ratio, or NPL ratio. The NPL ratio measures the quantum of loans that the borrower has problems servicing and is an indicator of how much of the loan book may be under stress. In simpler terms, the NPL ratio is an indication of the percentage of loans given out which have a possibility of defaulting.
During times of economic crisis, or during downturns, NPL ratios have been known to spike as companies that had borrowed money during the boom times experience financial difficulties.
CCB’s NPL ratio stood at 1.43% at the end of the first half of 2019, down slightly from 1.46% reported at the end of 2018. This is not a major cause for concern, and investors should only be worried if the NPL ratio rises to 4% or 5%.
Taking a quick look at CCB’s loan to deposit ratio and NPL’s, it shows that CCB’s risk profile improved in the first six months of 2019.
The improving risk profile is good for investors as they don’t have to worry about the bank being over-leveraged should the economy turn down even more, as the bank can easily cover its liabilities.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Hong Kong contributor Saket Jhajharia doesn’t own shares in any companies mentioned.