Are China's banks and finance firms ready for the government's economic reforms?

Reforms are being done amid slowing economy.

CEOs and senior executives of banks and non-bank financial institutions in China are preparing themselves for a period of intense reform as the central government moves to rebalance the economy and create a more resilient banking sector.

According to a release from PwC, many players are already looking beyond 2 or 3 years of difficult change and preparing for the medium to long term.

“The respondents to our survey accept that they are going though a period of significant risk and change,” says Matthew Phillips, PwC China and Hong Kong Financial Services Leader.

“To varying degrees, institutions are prepared for these, but the smart players are looking beyond to the changes they will need to make to their business models in a environment where credit is priced by the market, liquidity is prized and customer centricity is fundamental to everything they do.”

Here's more from PwC:

The government is implementing major reforms to this sector just as the economy is slowing and non-performing loans are mounting. The value of non-performing loans in China’s banks jumped 36% year-on-year to RMB 767 billion at the end of Q3 2014 – the sharpest rise in four years.

The NPL build-up is expected to continue well into 2015. At the same time, banks expect to see net interest margins squeezed to around 2%. This is a common level in most mature markets and means that banks in China will have to be less reliant on deposits and lending.

“The survey reveals a range of views on the severity of the situation. Most feel that NPLs will rise and that the situation will be risky, but manageable. Most also highlighted the significant reserves the banks have built up and noted that these could cover several years’ new write-offs at current run rates,” adds Mr Phillips.

The report also gives a detailed analysis of the effects of new entrants and products in the finance sector, such as web-based wealth management providers, P2P lenders, third party payment platforms and auto finance companies.

While these new players often directly challenge existing market participants, many of the banks surveyed said they saw more opportunities for cooperation than competition – a view reciprocated by Internet finance respondents.

“Traditional banks not only have to cope with a rapid pace of reform, but also with e-commerce giants becoming some of China’s largest fund managers in a matter of months,” says William Yung, Financial Services Partner for PwC China. “This has forced many banks to accelerate their innovation strategies and to start offering web-based services.”

“We believe that participants should adapt to digital implementation by co-operation. For example, banks, mobile operators and retailers are more likely to be successful at implementing payment platforms and other market changing innovations if they do so in cooperation, rather than individually.” adds Mr Phillips.

One of the areas of agreement is that interest rate liberalisation is inevitable – the only question is how quickly it will be pushed through during an economic slowdown. Banks also expect to see their margins suffer as their biggest clients start to raise money from capital markets – a move encouraged by the government.

To balance this, the report finds a great deal of scope for banks to differentiate themselves and generate fee income through service innovation, broadening their involvement in the capital markets and helping clients manage emerging financial risks.