The credit portfolios of the big four Chinese state banks are worsening thanks to a weaker housing market, and now the major lenders are getting serious about the non-performing loans on their books.
The Bank of Communications Bank of Communications, China's fifth-largest bank, assembled research teams last month to look over the assets of troubled borrowers in Zhejiang Province, according to bank sources and an internal document obtained by Reuters. The province is a hotbed of China's credit stress, the Shanghai Daily reported on Sunday.
China's big state owned banks have been blamed by investors for misrepresenting the actual amount of bad loans. Official record puts China's non-performers on par with world averages. But many investors, primarily those with a more bearish outlook, think the government banks have a major problem on their hands. Not only is the housing market shrinking, but the People's Bank of China Bank of China (PBoC) is also breathing down the necks of lenders who manage non-diversified trust funds. The government is aware of the credit problem and is doing its best to keep up appearances, at least.
One of the more famous trust fund duds was China Credit Equals Gold #1, which basically invested in a single company that had no revenues. The fund went belly up. It was connected to the world's largest bank, China's Industrial and Commercial Bank.
The Industrial and Commercial Bank of China, the country's largest bank, has run into major problems with asset management products. Now the big banks are trying to protect themselves from a rise in non-performing loans. As they rise, China's government is likely to sweep them under the rug as it did over 10 years ago.
Bankers from other major lenders said they were further cutting lending to riskier borrowers, in particular smaller private companies. The PBoC has been pushing for banks to lend to small businesses.
"We're lending almost exclusively to state-owned enterprises in our department at the moment, because it's just seen as the least risky," a senior loan officer at the Bank of China was quoted saying in Sunday's Shanghai Daily.
Management at the Bank of Communications had grown increasingly concerned about a surge in bad loans in July. In response, it set up teams to assess the situation in Zhejiang, Shandong, Fujian, Hubei and Guangdong provinces, according to Reuters.
China's official information on non-performing loans (NPLs) first became available in 1998, but the data from 1998 and 1999 probably under-estimated the actual size of the NPL problem, the National Bureau of Economic Research in Cambridge, Mass. said in a white paper dated February 2012. China's low-balling would explain the jump in the size of NPLs from 1999 to 2000. China's NPLs are the highest out of six countries, including the U.S., from 2000 to 2007. By 2010, the total value of NPLs fell by half to $68.1 billion, for a low 1.1%. Only Indonesia and Taiwan had better credit portfolios.
But since then, investors are back to doubting the numbers.
Official figures on outstanding loans in China never include the bad loans that have been transferred from banks to four state-owned asset management companies —basically China's toxic asset relief program. Those loans are still on the books, being rolled over year after year, unlikely ever to be paid in full.
The National Bureau of Economic Research said if China's actual NPLs were added to the toxic asset funds run by the big four, then "the total amount of non-performing loans would increase by two-thirds."
There's also a classification problem.
The Basel Committee for Bank Supervision classifies a loan as a non-performer when any interest payment is overdue by 180 days or more. In the U.S., non-performing loans are those overdue by 90 days.
But China plays by different rules. Classification of a non-performing loan is typically taken only when the principal payment is delayed beyond the loan maturity date or an extended due date. It's not just a matter of semantics. For investors, the credit bubble has become a matter of buy or sell Chinese stocks.
The good news is that China has been here before. And survived.
In the later 1990s and early 2000s, non-performing loans at state banks were estimated by Moody's Moody's to be as high as 45%. Everybody thought China banks would soon fail. However, monetary authorities came to the rescue. They simply wrote-off half of that debt without batting an eye, while the other half were taken off balance sheet and sold to newly created government-funded asset management companies at par value. Instead of suffering a Japan-style financial crisis, the economy entered a decade-long period of extraordinary high growth. And the loans, like the bad loans of today, were never paid off.
"China has a war chest of foreign exchange reserves that it finds difficult to dispense," wrote Yu Yongding, former president of the China Society of World Economics, in an op-ed published by Hong Kong based NGO, the China U.S. Exchange Foundation. He doubts there will be a full blown financial crisis in China any time soon. "When necessary, the Chinese government will not hesitate to inject capital from the reserves into commercial banks," he wrote.
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