China Gears Up to Tackle Banking Crisis 中国准备应对银行业危机

By newsdoug on June 5, 2012

A pair of new reports in the Chinese media appear to be readying markets for news that the nation’s banks are on the brink of a crisis, even as Beijing is already devising ways to save them from the flood of bad loans that everyone is expecting. Let’s look at the bigger of the 2 reports first, which has China’s banking regulator expressing surprise at the “contradictory” fact that China’s top banks have yet to report significant rises in their non-performing loans (NPLs), even though many have seen recent surges in some categories of loans considered “problematic”. (English article) The article goes into a bit of detail after that, but the implication is rather straightforward. In a nutshell, the regulator thinks the banks are lying about the magnitude of their bad loan problem, using word games to classify loans as “problematic” even when they are already clearly “non-performing” by industry standards. This kind of word game is completely standard procedure for big Chinese state-owned enterprises (SOEs) that are always eager to give the central government good news, which often means hiding their problems behind this kind of accounting trick. That eagerness was on display in their recently released first-quarter earnings reports, when top lender ICBC (HKEx: 1398; Shanghai: 601398) reported its NPL ratio at the end of March was a sparkling 0.89 percent, while Bank of China (HKEx: 3988; Shanghai: 601988), the industry’s third largest lender, reported an equally stellar NPL rate of 0.97 percent. The banks continue to say there’s no problem, even as just about everyone else suspects they are sitting on a growing pile of bad loans made during a lending binge that was part of Beijing’s economic 4 trillion yuan economic stimulus package at the height of the global downturn in 2009 and 2010. Many of those loans went to local governments for unnecessary infrastructure projects that had no real income sources with which to replay the debt. Most government were expecting to use land sales, which make up their main revenue source, to repay the debt; but that plan is quickly falling into doubt as Beijing shows no signs of easing policies to rein in the overheated real estate market, which has also dampened demand for new land for development. Earlier this year, Beijing indicated it might let the banks “restructure” many of their problematic loans to forestall the looming crisis, essentially allowing them to stop collecting payments for a year or 2 without officially classifying the loans as non-performing. (previous post) It’s unclear if the government ever officially gave the green light for that plan to go forward, but even if it didn’t many observers suspect the banks are using this and other similar accounting tactics to cover up the problems. Following this latest new probe by the regulator, I expect we’ll see most of the banks start to admit to their loan problems in the months ahead, with most confessing to NPL ratios of 3 percent or more by year end. In anticipation of that problem, Beijing is taking what looks to me like a second step to give the banks a relief mechanism to spread the bad loan problem more evenly around the country’s vast SOE system. That appears to be the message from the second piece of news I referred to at the start of this piece, which has Beijing launching a pilot program that will allow banks to securitize their loans and sell them off to other “investors”. (English article) I don’t mean to sound too cynical, but this program, which is starting with a relatively modest quota of 50 billion yuan, or less than $10 billion, looks suspiciously like a way for the banks to sell their bad loans to other major cash-rich SOEs if and when that becomes necessary. In a way, this kind of plan looks smart in helping to minimize the downside for individual companies by spreading the risk around a much wider base. But stock buyers who invest in these SOEs may hardly find that news comforting when, for example, investors in a big SOE like Sinopec (HKEx: 386; NYSE: SNP; Shanghai: 600028) suddenly discover their company is holding billions of dollars in securitized bad loans it purchased under orders from Beijing. Stay tuned for more of these kinds of smoke-and-mirror games as Beijing figures out how it wants to handle this looming financial mess and forces banks to admit to the problem.

Bottom line: Suspicions from China’s banking regulator indicate Beijing is making preparations to deal with its looming banking crisis, with potential plans to spread bad loans around the SOE system.

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