China's commercial banks and earthquake risk
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Earthquakes – big ones included – happen frequently in China. There are regions of high seismic activity, including in areas of economic development such as the Beijing-Tianjin-Hebei cluster. Through their branch networks in these areas, commercial banks own properties that are exposed to seismic risk events.
Many banks have traditional earthquake insurance for their property portfolio as part of their overall operational risk management strategies. However, the main source of vulnerability (ie, potential losses) from earthquakes for commercial banks' are their credit assets, not their own property interests. The credit assets are the loans/mortgages that commercial banks issue to businesses and households. Where borrowers suffer damage and losses due to an earthquake, they may not be able to adhere to loan repayment terms, and default. Borrowers can also buy traditional earthquake covers, but purchase is not mandatory and penetration is low. As such, default risk remains a reality.
Our latest Expertise Publication raises the question of whether enough is being done to help commercial banks in China protect themselves from all the risks that earthquakes pose. Depending on the locations of their credit assets, some banks could be susceptible to very large earnings hits in the event of a major earthquake, and many may not realise how vulnerable they are.
In this study, we estimate that around 32% of the loans issued by commercial banks in China are for assets located in areas of high earthquake risk. And, using Swiss Re's catastrophe modelling tool, we simulate that in a worst-case scenario, the banking sector as a whole could suffer default losses of up to CNY 336 billion, equivalent to 0.49% of total sector credit assets. Read the full report, also available in Chinese to find out more about our methodology and modelling of different seismic scenarios.
We also explain that new solutions exist for this apparent protection gap facing China's commercial banks: innovative parametric insurance products. An insurance payout from a parametric or index-based product is triggered when a pre-defined threshold on an index is reached, rather than being based on actual losses incurred after an event. The development of this type of product has been enabled by advances in technology and (digital) data analytics. The task for insurers and other stakeholders alike is to encourage their uptake.