Pessimistic forecasts for China’s banking sector

China’s first private bank posted a second-quarter net income 20% larger than the year before but triggered a sell-off at the Hong Kong exchange that dragged down other major Chinese banks.

China Merchants Bank Company, Ltd reported a net income of US$1.8 billion, a fifth over its comparable level in 2011, but also said its net interest margin fell 21 basis points from the prior quarter while non-performing loans rose by 4% from the prior half-year period.

The bank’s Hong Kong listed shares traded lower yesterday afternoon, as did those of China’s Big Four state-owned banks. Analysts remain pessimistic about the outlook for China’s banking sector

Brokers cited risks to China’s banking sector as a whole including the fallout if China’s growth rate slows significantly, and the potential for sudden changes in government regulation.

Bernstein Research believes that if China’s real GDP growth slows down to the 3% to 4% range, it would suspect that a number of businesses operating in China will default, resulting in a substantial deterioration of credit quality in the banking system.

J.P. Morgan also took a cautious tone towards China’s banking sector. It said that second-quarter results at CMB reflect the range and depth of issues facing the China banking sector.

CMB’s results came ahead of those from larger banks, including China Minsheng Banking Corporation, Agricultural Bank of China Ltd. and Bank of China Ltd., all of which are slated to release earnings on Thursday.