View Full Version : China still vulnerable despite war on bad debt

May 5, 2006, 05:47
China still vulnerable despite war on bad debt
By Richard McGregor
Published: May 4 2006 01:15 | Last updated: May 4 2006 04:09

At first glance, Beijing would appear to have tackled head-on the mountain of bad debt in its state banking system, debt which has built up over some 20 years since the government began opening the economy in the late 1970s.

In 1999 the government established bad-debt disposal companies to sell off sour loans, used bank profits to wipe out more and also pumped in cash from its foreign exchanges reserves to recapitalise the institutions.

In all, China cleared about $560bn (€444bn, £305bn) of bad debts in a flurry, an amount equal to about half the country’s gross domestic product at the time the funds were deployed.

Therefore, after a period during which China enjoyed boisterous economic growth rates, it is surprising that a series of new reports say non-performing loans (NPLs) remain stubbornly high and may be getting worse.

A report issued yesterday by Ernst & Young, the accountancy firm, puts China’s total liabilities for non-performing loans at just over $900bn, even higher than its $875bn stack of foreign reserves, the largest in the world.

The findings of the E&Y survey are broadly in line with a report by professional services firm PwC, issued last week and similar in tone to another lengthy report released this week from McKinsey, the consultancy, on China’s financial system.

“I think the numbers will be a big surprise because China has been giving the impression [with its banks listing overseas] that the problem is behind us,” said Jack Rodman, a managing director with E&Y. “China has not really resolved the issue – they have just moved it from one state enterprise to another.”

The three reports say the original stock of bad loans has not been dealt with and that a huge stack of new NPLs has been created.

“While there have been improvements in the banking sectors, and the government has sought to address NPLs, the core causes for the build-up have not been fully dealt with,” said the McKinsey report.

“Until these problems are addressed, the problem is likely to persist, and the banking system will remain vulnerable to potential liquidity shocks.”

The “problems” are familiar – a lack of commercial mindset among banks and skills to assess credit risk, and a sprawling nationwide branch system over which the head office in Beijing has little control.

The official figures are relatively rosy. The China Banking Regulatory Commission, only established in 2002, says the NPL ratio was more than halved to about 10 per cent in the three years to 2005.

Three of the big four state banks, which have either listed overseas or are preparing to, have an even better record, with their NPL ratio by December last year under 5 per cent, according to PwC. The fall was not due to NPL resolutions, but transfers to the bad debt disposal agencies, and a surge in new lending which made existing bad loans a smaller part of the expanding pie of banking assets.

“So while NPL ratios appear to be decreasing, in number NPLs are probably increasing,” says Mike Harris, the PwC report’s author.

The bad debt disposal agencies, known in China as asset-management companies (AMCs), have taken on about $330bn in sour loans since 1999, but have only resolved about $100bn.

Much of the 20 per cent cash recovery rate earned by the companies has been used to fund their operations, with the state receiving little, according to E&Y.

The Finance Ministry has had to keep carrying the burden of guaranteeing bonds issued to the banks by the AMCs when they took the loans on to their books.

The disposal market is in an even worse state because the AMCs have been bidding against each other, driving other potential investors, especially foreigners, out of the market.

Foreign investors are wary of returning to the China market because of the difficulty of getting clear title to the assets and the artificial reserve prices imposed on the auctions. Holding bad loan auctions almost invariably means setting prices for the sale of state assets, a sensitive issue for a government not wanting to be seen to be condoning firesales.

The failure to clarify these issues will haunt China as it seeks to revive auctions of bad loans this year.

Here's a link (http://news.ft.com/cms/s/fbe87b18-dafd-11da-aa09-0000779e2340.html) to the news article.