An update on China’s bad loans — $1 trillion is probably not a bad estimate

You will recall the previous estimates of $400 billlion to $1.2 trillion in bad loans in China that we have discussed. The high end estimate was from an E&Y study that was mysteriously withdrawn a few days after its release. George Friedman has looked at the issue and has come to conclusions similar to ours — namely that China’s bad loans are probably in the same ballpark as its foreign echange reserves. He quotes from a Fitch credit analysis report:

“Summing all of these figures, we come up with total official nonperforming loans of US$206 bn and other estimated problem loans of over US$270 bn in the banking system. We would reiterate, however, that a large portion of this latter figure is comprised of estimated Special Mention loans or loans that currently are not classified as nonperforming. At the same time, there is an additional US$197 bn in NPL carveouts still remaining on the balance sheets of China’s asset management companies, which no longer represent direct losses for banks but are a future liability for the government.”…

“Beyond this, estimating a rate of flow of new nonperforming loans is not an easy exercise given Chinese banks’ extremely weak historical data and ongoing deficiencies in accounting and disclosure. Few banks report data on NPL flows, and those that do show recent flow rates in the extremely low single digits. We believe these numbers understate the likely level of ultimate credit losses, given what we know to be the slow evolution of a strong credit culture and risk management practices and our suspicion that China’s over-reliance on investment-led growth comes at a cost to bank credit quality.”

We’d be tempted to call the coming bad loan crisis in China its version of the 1980’s junk bond debacle in the United States, the one that triggered the S&L crisis, but that would be wrong. The US had a myriad of mechanisms for working out bad loans, including equity markets, LBO funds, and a substantial infrastructure devoted to the bad debt industry and dependent upon the transparent financial disclosure system in the United States. Still, the US had to set up special mechanisms to deal with the S&L crisis, and the workout took years. China has none of this infrastructure, and it remains to be seen if the country has the political will of South Korea to face the problems, or the timidity of Japan. Japan’s timidity and inaction spread the pain out over a decade. China, with its nascent international presence, can scarecely afford to go that route, but who is to say that it will not.

The other day, we referred to China’s huge, and hugely popular bank IPO’s as its internet bubble. Let’s hope that this is one bubble that doesn’t burst anytime soon.

Leave a Reply