Monday, October 23, 2006

A colleague sent the following article highlighting the likely increase in non-performing loans in the near future, and the warning came from PBOC vice governor Wu Xiaoling. I think that the numbers might not show up immediately due to the variety of ways to hide it or write-down bad debt in China.

You are right that NPL amount will surely rise, and with lending slowing dow, the ratio could also rise again. However, with all kinds of money sloshing around, they can mobilize numerous accounting tricks to cover or "solve" the problem right away. For example, if a major provincial construction project is in trouble, they can have the State Development Bank make a long-term loan to the province, which it then uses to repay the commercial bank....etc. Huijin and the Social Security Fund can likewise inject money through buying equity stakes in various provincial investment companies. The possibilities are endless. This is why there has been a steady growth in the ratio of long-term loans. With long-term loans, the banks know almost nothing about the performance of the borrowers, except that they are making their payments.....

Monday, October 23, 2006
Bad loans 'could rise again'


A central bank offical has warned that bad loans in the banking system
remain a "huge and difficult" challenge even as the nation's largest
lender completes a world record share sale.
"The foundation for sound asset quality still isn't solid," People's
Bank of China deputy governor Wu Xiaoling told a financial conference
in Beijing, according to the sina.com website Monday.

"The task of avoiding a rebound in non-performing loans is still huge
and difficult," she was quoted as saying at the conference on Sunday.
Ms Wu made the remarks a day before the Industrial and Commercial Bank
of China (ICBC) announced the pricing of its much-anticipated initial
public offering, setting the stage for what is likely to be a US$22
billion (HK$172 billion).

Ms Wu noted that China's state banks still relied heavily on net
interest margins - the difference between what a bank earns in interest
on loans and what it must pay on deposits - and said lenders remained
vulnerable to any change in the economic weather. "Any changes in
macroeconomic conditions will directly impact bank asset quality and
therefore impact the profitability and stability of the banks," she

China's banks were less than ideally positioned to respond to such
challenges, according to the central banker. "China's state-owned
commercial banks lack high-quality talent, even as they are over-
staffed and suffer from low-efficiency allocation of their personnel,"
she said.

The non-performing loan ratio of China's banks dropped to 7.5 per cent
at the end of June, down 1.1 percentage points from the end of last
year, according to previously released data from the banking
regulator. Analysts acknowledge that lending practices have generally
improved over the past several years but also warn that the decline was
really due to government bailouts and aggressive lending in the current
liquidity-fuelled boom.

Since bad debt is calculated as a percentage of assets, an increase in
bank lending can reduce the proportional level of sour loans. The 7.5
per cent level cited by the regulator would be considered almost a
crisis in a developed market economy but represents a huge improvement
in China where foreign analysts estimated that as many as 40 per cent
of all bank loans had gone bad before the current round of reforms.

The ICBC is the third of the big four banks to go public, following
the initial public offerings of Bank of China and the China
Construction Bank. Their share sales followed ambitious restructuring
drives, the injection of a combined US$60 billion and the introduction
of strategic investors. The ICBC received a US$15 billion injection
prior to its IPO.

The Agricultural Bank of China, the only unlisted big four bank and
the worst-performing of the group, might receive a large bailout from
Beijing next year, according to state media.

It's not that easy. The State Development Bank would have to loan money to a provincial government, which would have to fund an investment corporation, which would have to transfer money to the SOE, which would then repay the bank. The trouble is that at some point, if someone says no, then this won't work.

Central Huijin and the Central Social Security Fund couldn't inject cash into a company without a *lot* of people noticing. It's also improbable that a local social security fund would be able to inject funds into a company through equity purchases without a lot of people noticing. In particular, if they were to purchase equity in a listed company, they'd have to do an IPO, and the CSRC would notice.

It's not that it is impossible to make these sort of deals, but it is increasingly difficult to do it without someone noticing, and if there is a major problem in the NPL's then it is very unlikely that you'd be able to hide it for very long through bookkeepping.

It's because of the above that I don't think that there is a big problem with NPL's in three of the four state banks. Things are a lot more murky with the JSCB's.
Spirited defense, but the SDB in fact has been going on a wild binge. Since 2003, CDB handed out a series of US 6-9 billion financing agreements to some 20 provincial governments, totaling over US 125 billion. Tianjin, for example, received two packages of loans worth over US 7.5 billion within a few years. At the end of last year, when Chen Yuan met with Xinjiang party secretary and Politburo member Wang Lequan, Chen increased CDB’s commitment to Xinjiang from the original US 2.5 billion to US 6 billion.
Just to be clear to the readers of this blog, the SDB's are policy banks whose loans are not intended to be commercially based, and are intended for the type of thing that would be financed by municipal bonds in the United States. (Since there is no municipal bond market in China.)

But it still wouldn't work to use the SDB's to do a bailout of the commercial banks. Total assets of the big-four commercial banks is about $2 trillion. If 10% go NPL, that's $200 billion which is more money than the CDB has. Also, in order to earmark CDB money to do a bailout of SOE's would require an administrative structure that doesn't exist (i.e. ordering a province to spend a loan on a particular SOE), and couldn't be created without a lot of people noticing.

If the Chinese economy looked like it was going into recession, the government could order CDB to boost lending to provincial governments as a fiscal stimulus. But this sort of thing is perfectly fine.
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