CHINA / Foreign Media on China
Probing the puzzle of Chinese banking
By Ted Plafker (International Herald )
Updated: 2006-10-30 18:00
As foreign investors contemplate the health of the Chinese economy and
the ultimate sustainability of the unfolding Chinese miracle, one focus
is the level of bad debts held by the biggest Chinese banks.
Some of the gloomiest prognosticators warn that Chinese banks are rife
with nonperforming loans far greater than those officially acknowledged
by the government and that, sooner or later, a financial train wreck is
inevitable.
Other, more optimistic analysts argue that much of the bad debt in the
system really is government debt in disguise, and therefore is
effectively backed by the massive foreign reserve assets of the central
bank.
China has been working since the late 1990's, through a variety of
mechanisms, to clean up the banks' balance sheets and prepare them for
partial privatization. With direct capital injections from the government
and through the transfer of bad loans to specially created asset
management companies, debts worth hundreds of billions of dollars have
been written off.
More recently, tens of billions of dollars have been raised through the
sale of shares in some of the largest state banks to Chinese and foreign
investors, strengthening their capital base.
Yet, in testimony before the U.S. Congress in August, Gordon Chang, an
author and China analyst, said that even after this cleanup,
nonperforming loans at Chinese banks still amounted to 40 percent of the
gross domestic product of China, and about half of China's total
indebtedness.
Making what he called a "conservative" estimate that excluded many
significant bank and government obligations, Chang put China's overall
debt- to-GDP ratio at 81 percent. That estimate included government debt
to other governments and multilateral institutions, central government
debt incurred on behalf of local authorities, and banking system debt.
But it excluded welfare system obligations, grain subsidies and debts in
the defense sector.
According to China's own calculations, the ratio of state sector debt to
gross domestic product stands at only 18 percent, far short of the 60
percent level that is internationally regarded as a threshold of alarm.
Few independent analysts take China's data at face value.
Poor accounting standards and a lack of transparency undermine the
credibility of official financial data, while some analysts say that they
suspect the government may be intentionally concealing bad loans to
minimize concerns about debt volume and quality.
"No matter how you calculate this ratio, China has too much debt," Chang
told the congressional U.S.-China Economic and Security Review Commission.
How exactly should China's debt be calculated? Part of the answer rests
on how "loans" themselves are defined. In significant ways, Chinese bank
loans need to be defined differently.
The true value of Chinese nonperforming loans is difficult to calculate,
but certainly is "massive," said Louis- Vincent Gave, a partner in
GaveKal, a research firm based in Hong Kong. At the same time, he said,
outsiders may be overly concerned about the risks.
"The reality," Gave said, "is that Chinese banks have often acted as a
financing arm of the government. So it's not like Japan or the United
States or France, where you have bad loans that force banks to contract
lending, which leads to an economic slowdown. In China, the bad bank
loans are actually on the government books."
For comparison, Gave cited the emergency ��00 million, or $507 million,
bridge loan provided last year by the Italian government for a bailout of
the chronically troubled national airline, Alitalia.
That loan was replaced in December by a complex financial restructuring
in which the airline raised fresh capital from investors and split off a
ground services and debt-holding unit, AZ Servizi, in which an Italian
state financial company took a 49 percent holding.
In a similar scenario in China, Gave said, a failing airline would simply
call the government to say that it was about to fold, and the government
would instruct a state bank to issue the loan.
"So in China, this would show up as a bad bank loan instead of a
government debt, and it happens all the time," he said.
During China's central planning heyday, virtually all bank loans were
"policy loans" mandated by the government with no concern for
profitability or borrowers' creditworthiness.
When economic reforms started 25 years ago, lending began a partial shift
toward commercial terms. Still, reckless lending remained common among
banks that had both cash and a new freedom to pursue business, while
lacking the tools to evaluate risk.
According to Jin Liqun, a former Chinese vice minister of finance and now
vice president of the Asian Development Bank, many nonperforming loans
were accumulated in the late 1990s when economic growth was high but the
banking system remained weak.
"Chinese banks took the chance to pounce on what they thought would be
good opportunities, but now bankers are much more prudent," he said.
Policy lending undoubtedly has declined, in large part because so much of
the Chinese economy is now in private hands. According to the brokerage
CLSA, the Chinese private sector is now responsible for more than 70
percent of the country's GDP, and employs about 75 percent of the total
workforce.
According to the Chinese government, the quality of bank loan portfolios
is starting to improve. State banking regulators reported in August that
the percentage of bank lending classified as "nonperforming" fell by 1.1
percentage points to 7.5 percent in the first half of this year.
But some analysts point out that many factors can give the illusion of an
improvement. By simply expanding their new lending, for example, banks
can show a lower bad-loan ratio, even though the quality of new risk -
like lending to speculative real estate developers - may be questionable.
Michael Pettis, an associate professor of finance at the Beijing
University Guanghua School of Management, also warns that official
Chinese definitions of nonperforming loans differ from internationally
accepted standards. Many bad loans are not being properly tallied as
such, he says.
Chinese officials themselves remain cautious in their claims on the
subject.
Wu Xiaoling, the deputy governor of China's central bank, the People's
Bank of China, said this month that Chinese banks still lacked the
necessary expertise to lend effectively, and that asset quality remained
suspect.
"The task of avoiding a rebound in nonperforming loans is still huge and
difficult," she said during a Beijing finance conference a week ago.
But Gave and other analysts downplay the problem, maintaining that much
of China's bank debt is more like government debt, and its strong foreign
reserve position makes it a creditable guarantor of that debt.
"I just don't see how the so-called train wreck would happen," Gave said.
"A train wreck implies a forced seller, and I can't see the Chinese
government as a forced seller," he said.
On the other hand, Gave warned, foreign investors looking to put money
into Chinese banks should beware of the possibility that a future
economic slowdown could motivate the government "to order banks to cough
up money in new loans to support flagging growth."
Pettis, meanwhile, noted that China's large foreign currency reserves,
standing at around $1 trillion, were matched by a similar amount of
government debt. China could not tap those reserves without increasing
its net indebtedness, he said.
Chinese debt is a clear concern at a time when both Chinese and global
growth are strong and liquidity is high, Pettis said.
"This is as good as it gets: it's the sweet spot," he said. Possible
future developments, ranging from an economic hard landing in the United
States to a liquidity squeeze in China, would only make things harder.
"Until we know how much hidden and indirect debt there is, no one can
honestly say the creditworthiness of the Chinese government is not an
issue," Pettis said.
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