As most of my courses at Tsinghua University include interesting aspects of the Chinese economy, there is another part of one of my papers that seems to be worth sharing: the issue of non-performing loans (NPL), which has puzzled both banks and the government for a long time:
When the Chinese banking system is discussed on an international basis, it usually does not take a long time until the topic of non-performing loans (NPL) is brought up. Since 1998, Beijing has injected 105 billion USD into the banking system (Farrell et al., 2006, p. 36) and – according to Bremner (2006a) – transferred NPLs worth roughly 400 billion to four state-managed asset management companies (AMC). Even though officially reported NPLs have fallen from 31 per cent of total balance sheet values in 2001 to 10 per cent in 2005, nevertheless 60 per cent of this decline is due to the shift to AMCs described above. So far, the average recovery rate within those AMCs has only been 20.5 per cent (Farrell et al., 2006, p. 14 & 32).
The reduction of the NPL ratio is also fueled by a sharp increase in overall lending activities: between 2001 and 2004, Chinese banks issued new loans amounting to between 156 and 331 trillion RMB, which represented between 13.3 and 23.3. per cent of total GDP (Id., p. 34).
Nevertheless, the remaining NPLs still have a total value of 125 billion USD representing 6.5 per cent of China’s GDP. While all above numbers are based on official bad loan rates, the actual rate may be even higher: According to a study by UBS, the true value of NPLs lies around 500 billion USD, 200 billion higher than the official value (Anderson, 2004).
Interestingly, China’s NPLs have become a much sought-for investment opportunity for international banks: according to PricewaterhouseCoopers, international investors like Morgan Stanley or Goldman Sachs have bought NPLs totaling over 15 billion USD and the market is not expected to slow down soon (PwC, 2006, p. 2). Even though this shows that the distressed securities market has become a reasonable investing opportunity, it nevertheless does not hide the fact that China does indeed still have a serious non-performing loan problem.
China’s NPL issue is most probably due to the special lending patterns and missing balance in the financial market. A recent study by McKinsey and Company has identified three main factors leading to those anomalies in lending patterns:
- Weak Governance And Lack of Commercial Mindset: State ownership of banks in China is extremely high as the government still controls 83% of all assets in the financial sector. This number is also very high when compared to Eastern Europe’s transitional economies where state ownership today on average is below 15% (Farrell et al., 2006, p. 35).
- Operational Weaknesses: Even though the large banks have already taken measures to improve their management and lending skills, those are still low compared to other countries. Especially the lack of good internal credit assessment capabilities is a big problem, as lending decisions today are still often based on incomplete data with insufficient analysis in many parts of China, due in part to the poor quality and unreliability of many companies’ financial statements (Farrell et al., 2006, p. 37). A study by Nihon Keizai Shimbun shows that state commercial banks today grant 96% of loans at a multiple of less than 1.3 of the government benchmark. In comparison, local credit cooperatives seem to spend more time on credit risk assessment: they only make 18% of their loans below a multiple of 1.3 of the benchmark. (Farrell, Lund & Morin, 2006, p. 6). In addition, the country is still in the early stages of developing a credit bureau and lacks full coverage of large rating agencies (Id, p. 19 & 38; Ye, 2006).
- Decentralized Structure: Even though China is a socialist transformation economy, economic central control is weaker than one would expect, which is also true for the financial sector: local organizations still have a large degree of autonomy, making it more difficult to establish corporation-wide standards (Farrell et al., 2006, p.40). Thus, lending decisions on the provincial level are more likely to be influenced by local politics. Furthermore, the sharing of credit information among banks is not established so that lenders who defaulted with one bank can easily get loans from another bank (Id.).
References
Anderson, J. (2005). How to Think About China. UBS Report.
Bremner, B. (2006a, Feb. 06). Banking on China’s Reforms. BusinessWeek Online Edition. Found on November 27, 2006
here.
Farell, D., Lund, S., Morin, F. (2006, July). The promise and perils of China’s banking system. The McKinsey Quarterly.
Farell, D., Lund, S., Rosenfeld, J, Morin, F., Gupta, N. & Greenberg, E. (2006). Putting China’s Capital to Work: The Value of Financial System Reform. McKinsey Global Institute Report.
PricewaterhouseCoopers (2006, May).
NPL Asia. Issue 7. Found on November 27, 2006
here.
