Agricultural Bank of China Ltd., the lender with more retail customers than the population of the euro zone, set aside more money for future bad loans amid the nation’s economic slowdown.

The bank boosted provisions for potential soured credit by 56 percent to 15.6 billion yuan ($2.5 billion) in the three months ended June 30 from a year earlier, according to a Hong Kong exchange filing yesterday. Net income rose 12 percent, the weakest pace in five quarters, to 50.6 billion yuan.

The government-controlled lender set up by Mao Zedong in 1951 to finance rural cooperatives is hampered by bad loans rising faster in the countryside than in urban areas. Projections for the nation’s economy to grow this year at the weakest pace since 1990 indicate further constraints on profit.

“The bank’s profit growth may further slow in the second half as China’s overall economy is not improving as much as people expected,” Richard Cao, a Shenzhen-based analyst at Guotai Junan Securities HK Ltd., said by phone. “Fee-income growth may come under pressure for the rest of the year.”

The operating environment for Chinese banks is deteriorating amid an economic slowdown. Credit expansion in the world’s second-largest economy plunged last month and investment spending unexpectedly slowed, adding risks to growth as a property slump threatens more defaults. Bank of China Ltd. said last week that it had more than doubled its bad-loan provisions from a year earlier.

Shares Slip

The lender’s shares were unchanged in Shanghai and Hong Kong as of 10:15 a.m. local time. The stock has fallen 0.8 percent this year in Shanghai and about 4 percent in Hong Kong on rising default risk, heightened competition for deposits and weaker credit demand.

Agricultural Bank’s profit growth compared with the 50.2 billion yuan average of 11 estimates compiled by Bloomberg. Net fee and commission income fell 3 percent to 21 billion yuan in the second quarter from a year earlier.

The Beijing-based lender, whose 450 million retail customers outnumber the population of the euro zone, benefits from lower deposit costs due to its extensive branch network in county areas. The average cost of deposits for the first half was 1.81 percent, which remained the least among peers, the bank said yesterday.

Bad-Loan Ratio

The bank’s nonperforming loan ratio widened to 1.24 percent at the end of June from 1.22 percent at the beginning of the year. At its county operations, the level increased to 1.6 percent from 1.54 percent. Pretax profit at the county business fell 5.8 percent in the first half to 43.9 billion yuan, according to yesterday’s statement.

Any further decline in the bank’s rural-asset quality may be limited, with China’s lenders facing greater risks from credit extended to industries with excess capacity, Leon Qi, a Hong Kong-based analyst at Daiwa Securities Group Inc., said in a note.

Banks’ appetite for risks has declined due to deteriorating corporate health amid the economic slowdown, Mao Junhua, a Beijing-based analyst at China International Capital Corp., wrote in an Aug. 15 note. The central bank needs to cut interest rates to encourage bank lending and help the economy, the analyst wrote.

The economy will expand 7.4 percent this year, according to the median estimate in a Bloomberg News survey.

Mortgage Risks

President Zhang Yun said yesterday at a briefing in Beijing that risks tied to mortgage loans are controllable. Residential mortgage loans accounted for 63 percent of Agricultural Bank’s total retail loans, the lender said in its first-half report.

Chinese banks’ nonperforming loans have climbed for almost three years, the longest run since 2004 when the regulator began to issue the data on a quarterly basis, to reach 694.4 billion yuan as of June 30, data from the China Banking Regulatory Commission showed.

The industry’s bad-loan coverage ratio, which measures the money banks set aside for soured assets, narrowed to 263 percent as of June 30 from 274 percent three months earlier, according to the banking regulator.

Agricultural Bank is joining rivals such as Industrial & Commercial Bank of China Ltd. and Bank of China in planning sales of subordinated securities to replenish their Tier-1 capital to meet tougher requirements as profit growth slows. The lender calls the securities preference shares.

China’s five largest banks may face a combined capital shortfall of as much as $77 billion by the end of 2018, Jim Antos, a Hong Kong-based analyst at Mizuho Securities Asia, estimated this month. Agricultural Bank may raise as much as 40 billion yuan from selling the securities this year as part of its plan to raise a total of 80 billion yuan, it said Aug. 15.

Under China’s implementation of Basel III guidelines, systemically important banks need a minimum Tier 1 capital ratio of 9.5 percent, with total buffers of 11.5 percent, before the end of 2018.

Bloomberg