This isn’t the bottom for Chinese banks’ bad loans. Be prepared for more and weaker balance sheets.

China’s lenders reported large declines in net profit for the first time in decades Sunday, citing dire economic conditions fueled by Covid-19. In preparation to deal with ballooning bad debts and future losses, provisions rose sharply by 656 billion yuan ($95.8 billion) for souring loans. Prudent as that may seem, the worst is yet to appear.

Much of this isn’t a surprise. Between small enterprises struggling before the outbreak, to the pandemic itself and now the bumpy recovery, these were going to be brutal times for lenders. The economic gloom cast by the virus has given banks a reason to bring out the worst of their assets. Under new accounting rules, they need to provision more upfront if they expect things to deteriorate. It appears they do.

Consider what’s happening with bad debts. The industry regulator has already said that banks will dispose of 3.4 trillion yuan of bad loans this year, up almost 50% from 2019. In the first half of 2020, 1.1 trillion yuan were written off. Compare that to the 5.8 trillion yuan of such loans culled from the books between 2016 and 2019. In addition, the regulator says that about 4% of banks’ troubled debts have been “deferred,” equivalent to about 7 trillion yuan of loans headed for delinquency and put on hold until next year.  

System-wide non-performing loans rose by more than 300 billion yuan between January and June this year. Last week, authorities said the value of outstanding non-performing loans for small companies was reaching its tolerance limit at 400 billion yuan, rising 9.25% in the first half, but they’re giving companies and banks room to manage the tough terrain.  

Yet the reality is, bank assets are also growing because Beijing is pushing credit to shore up sentiment and keep companies afloat. Authorities aren’t ready to let the shutters come down on businesses that aren’t viable. At China Construction Bank Corp., the world’s second-largest lender by assets, for instance, loans to small and medium enterprises grew 31% in the first half compared to the previous period, or 8% of total loans. These companies were struggling even before Covid-19. Their debts were at risk and future borrowings may be even tougher to manage. Meanwhile, non-loan assets are rising as shadow banking rears its head again while regulators delay new rules to rein it in.  

Moody’s Investors Service expects “a considerable lag time before NPL metrics fully capture the increase in loan delinquency pressure.” Weak consumer sentiment and slow recovery from the pandemic will keep the squeeze on bank assets. According to the rating agency, non-performing loans across the $45 trillion banking system rose to 1.94% in the first half from 1.86% at the end of 2019, “led by regional banks” that mainly lend to China’s millions of small businesses.

With defaults rising despite forbearance, it’s difficult to see how this is the bottom. For now, there’s little trust, with banks trading at multiyear lows in terms of price-to-book value. Maybe it’s the moment to clean up balance sheets and give investors a better look at the books. They may actually begin to see the real case for value in Chinese bank stocks.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Anjani Trivedi is a Bloomberg Opinion columnist covering industrial companies in Asia. She previously worked for the Wall Street Journal.

For more articles like this, please visit us at bloomberg.com/opinion

©2020 Bloomberg L.P.