Monday, February 21, 2005

Well, back to my favorite topic, non-performing loans. According to the SCMP piece below, Chinese banks actually had a net increase in NPL amount, although the ratio fell in 2004. The only reason official figures report a drop in both NPL ratio and absolute NPL amount is that 50 billion USD was transferred from the foreign exchange reserve to the BOC and CCB to help them write-off NPLs. Without the write-off, China's NPL would stand at 2.18 trillion RMB, which is "just" 16% of GDP . China had high growth this year and now has a GDP of some 13.65 trillion RMB.

However, this NPL figure only includes the 16 largest banks in China and does not include NPLs in the smaller city commercial banks and all of the rural credit cooperative. To be fair, all of the NPLs in those institutions together are unlikely to surpass 0.5 trillion RMB. The other issue is false reporting by branch banks. Because of intense pressure to reduce NPL ratio, many branch banks have falsified NPL ratios or have hid them by rolling over loans. No one really knows the magnitude of this problem, but the problem might well add another 10% to China's NPL ratio.

Nonetheless, even with all of these problems, the Chinese banking sector has clearly made enormous progress in dealing with the NPL problem. The combination of rapid credit expansion, conservative lending policies, and tough over-sight by the CBRC has reduced NPL ratio from an official level of over 30% to 13.2%. Estimated NPL as a percentage of GDP has fallen from roughly 50% to now no more than 30%. In hindsight, the creation of the CBRC turned out to be a right decision. Basically, you can't trust the PBOC to monitor banks since they have multiple objectives (growth, low inflation, financial stability). They willingly sacrifice prudent lending practices if it would serve another goal. By creating a bureaucracy with the sole mission to decrease NPL, you create incentive for a subset of actors to pursue this goal in order to get promotion. Thus, Liu Mingkang turned out to be a zealous advocate of the NPL reduction cause.

The only troubling prospect on the horizon is what will happen to all of these long-term fixed asset loans. Basically, banks have switched from specializing in short-term working capital loans to SOEs to long-term fixed asset loans for government projects and real-estate in the past six years. A lot of these long-term loans are still "healthy," but will they stay this way?

South China Morning Post
Monday, February 21, 2005

Regulator takes state lenders to task on bad-loan figures
Officials say mainland banks have made no real progress in cleaning up their act

MARK O'NEILL in Shanghai

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Since China's banking regulator published last year's non-performing loan (NPL) statistics for state-owned banks last month, state media have been crowing about a historic policy success.

They call it a "double reduction" in bad loans: a drop in the absolute amount of outstanding bad loans and in the NPL ratio, adding that, as it was the third year of "double reduction", there is hope the NPL problem has finally been solved.

A closer look, however, reveals that the situation last year was actually worse than the previous two. The ratios fell only because of significant one-off disposals of bad loans in May and June and a rise in overall lending.

In short, the patient is better because the symptoms have been masked, not because the illness is being cured. Many fear the NPL figures will get worse this year as companies and projects fail in a climate of tight money.

And not all of officialdom is cheering last year's NPL statistics. China Banking Regulatory Commission (CBRC) deputy chairman Shi Jiliang made a critique of the state banks just three days after the results were released on January 13.

"The Bank of China [BOC] and China Construction Bank [CCB] have shown some preliminary progress, but their task ahead is very onerous ... the state banks have the same defects as state companies, with low efficiency, poor internal management and `everyone eating out of the same pot'.

"They have an enormous amount [of work] to do to change their true nature, stop a worsening of their assets and change from being state banks into real commercial banks," he told an international seminar in Beijing.

"If we analyse the figures coolly and include the assets from the two banks that were transferred and use the original specifications, then the NPL amounts rose to some extent. This is certainly a matter of great concern."

The CBRC has good reasons to be unhappy. Since its foundation in 2003, it has made the improvement of risk management its top priority. Its chairman, Liu Mingkang, has been constantly on the road at home and abroad, preaching the virtues of good lending practices and corporate governance. He has overseen the drafting of regulations and establishment of a risk-control committee within the banks.

The worse than expected NPL figures are thus a big disappointment. China still has Asia's biggest NPL volume after Japan.

The CBRC figures showed the outstanding amount of NPLs of the 16 major banks at the end of last year had fallen by 394.6 billion yuan from a year earlier but still totalled a staggering 1.71 trillion yuan. The NPL ratio fell from 17.8 per cent at the end of 2003 to 13.2 per cent. The big four state banks' NPLs alone fell from 1.92 trillion yuan to 1.57 trillion yuan, a drop from 20.4 per cent to 15.6 per cent.

What the CBRC should have added was last year BOC and CCB transferred more than 470 billion yuan in bad assets to their asset management companies (AMCs). In short, the mountain of NPLs would have exceeded two trillion yuan without the transfers.

Some of the braver domestic media said figuratively that the emperor had no clothes.

"This fall in NPLs is in some sense playing with numbers," said an angry commentary in the China Business Post. "In speaking to the public, especially those not in the financial community, we should be frank and transparent."

It also noted that the recovery rate of NPL loans by the four AMCs which took the bad loans from the banks was only 20.2 per cent last year, which meant that the government and the public would have to cover the remaining 80 per cent. "So, is the reduction in NPL ratios anything for the taxpayer to be happy about?" the commentary asked.

The issue then is less the NPL ratio than whether the banks have changed their nature and are being run as modern financial institutions, making loan decisions for commercial and not policy reasons, doing risk assessment and holding officers responsible for their decisions.

The banks argued they were the victims of the government's decision in April to cool the economy, which translated into orders to reduce lending to the cement, steel, car, aluminium and other sectors.

As it was a blanket order, it meant they had to stop lending even to projects and companies they considered promising. So, a loan they had extended to a project that had not been completed and to which they could no longer lend became an NPL.

They also complained that local governments forced them to lend money for priority projects - especially infrastructure - so it was unfair to judge them by the same criteria as foreign privately-owned banks. In short, they are saying the NPL problem is not one for which they should be wholly blamed and that they are victims of China's hybrid half-planned, half-market financial system.

Great blog. I handle commercial finance as well.
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