China boasts perhaps one of the most interesting (and certainly one of the largest) economies on the planet. The world’s largest exporter has maintained steady growth over the last 25 years, and whilst that economy might have slowed recently (due in no small part to an escalating trade war with the United States), by-and-large, China’s economy is still in a healthy place.
Indeed, economists are predicting a growth of 6.3% throughout 2019. However, whilst still growth, it is the weakest seen on record since 1990. Analysts predict a further loss of momentum until policy support steps start to kick in.
Still, whilst China’s economy might currently be slowing, consumption is growing as a share of GDP and all signs point towards the last year of slowdown being little more than a minor slip. So, there is still plenty for other banks and lenders in the neighbouring Southeast Asian region to learn from how the government has tackled and is currently tackling bad debt - both in terms of what to do and what not to do.
According to Deloitte, 47.2% of the banking market in China is held by the four major banks. In 1999, four centrally-controlled asset management companies (called “AMCs”) were set up to offload the billions of dollars’ worth of debt accrued by these banks. The process, which accounted for up to 24% of total loans, amounted to a recapitalisation of the sector.
Gathering any concrete data on these AMCs is next to impossible (what with the secretive nature of the Chinese banking sector) but in assets, these entities alone are similar in size and scale to the entire US banking market.
Above all else, however, the Chinese banking landscape is primarily dominated by non-performing loans.
Amid last year’s economic slowdown, the NPL ratio of commercial banks in China hit a 10-year high of 1.89%, with the total NPLs of commercial banks amounting to around $296.52 billion by the end of 2018 before reaching $317.66 billion earlier this year.
For investors, China is one of the biggest NPL markets outside of Europe. A recent survey found that 57% of them had invested in Chinese NPLs in the past two years and that 33% are certain to invest in the near future. This investment growth has been facilitated by structural reforms to the wilfully opaque Chinese legal system, which has given greater legal clarity to said system and laid the foundations for foreign investors to sweep in.
Major players, such as global asset management firm Oaktree Capital, are currently (though cautiously) looking at NPLs in China, and with good reason - the numbers are very big indeed and China is still an adolescent in terms of its economic growth potential.
The government, meanwhile, has been testing initiatives that facilitate offshore investment in NPLs. In June 2017, they launched a pilot programme to enable cross-border NPL disposals and in May 2018, they extended and enhanced the programme that allows commercial banks to engage in private sales of NPLs to bypass court-administered processes.
The sheer number of NPLs flooding the Chinese market is largely due to a regulatory shift that was necessitated as a result of something that’s been poisoning the well in China for a while now - all the bad debt its banks have been hiding. This was being achieved by banks classifying their NPLs as “special mention loans.” In other words - loans that were late, but not yet non-performing. This means that these banks were able to report very low, but very false, NPL ratios.
Of course, the banking industry in China is notoriously secretive, so what has the government been doing to lift the veil and sort out the mess underneath?
The Chinese government is committed to supporting the economy with fiscal stimulus strategies and an accommodative monetary policy. After the economic cooling of 2018, the government told banks to increase financial support for private firms in order to aid the economy. A joint circular, issued by the Communist Party Central Committee and the State Council, declared: “Financial regulators must enhance supervision, while fiscal authorities also must make full use of fiscal and tax policy and play its role as investor of state-owned financial institutions.”
This was a bold move, of course. But the real question is – who is eventually going to pay for it? China’s regulators are already walking a tightrope as they balance the need to keep credit flowing with making sure that bad debts don’t spiral out of control.
Currently, the handling of NPLs has become a top priority, with President Xi Jinping making it his mission to reduce corporate indebtedness. Banks across the country are also stepping up disposals of bad debt. Indeed, in 2018, Chinese banks resolved almost $300 billion in soured assets, compared with just over $200 billion in 2017.
It's regulators, however, that have been making the really major moves, with Chinese authorities taking significant measures to rein in all of that bad debt hiding. Last year, regulators forced banks to start recognising this bad debt as what it actually was, which resulted in around $258 billion hitting the market for bad debt sales.
The China Banking and Insurance Regulatory Commission has also, in recent months, accelerated the recognition of NPLs by informing banks that they must classify corporate loans overdue for more than 60 days as non-performing, which is down from 90 days previously. This is an act that hopes to ensure that banks can have bad credit exposed as early as possible and make up the shortfall in a bumper year. Wang Yifeng, a chief banking analyst at Beijing-based Everbright Securities, said: “For listed banks, the move will increase their NPL balance by about 50 billion to 70 billion yuan,” which is around $10 billion.
Many of the country’s big state-owned lenders have already been making provisions since last year and utilising more stringent NPL recognition practices to avoid the impact of these new regulations.
The cost of avoiding the regulations is not to be dismissed as wrist-slapping. In the last month, at least five major institutions, including a branch of the Industrial and Commercial Bank of China (ICBC), received penalties for hiding bad debt and whilst those amounts might be comparatively small, they are at least large enough to prevent others from doing likewise. The move also led to a record quarterly surge in soured debt and even wiped out capital at some small lenders.
According to Wang Ke, VP at Shanghai-based conglomerate Win Group: “The aim of such a tight policy is to expose the problems at the banks to regulators because banks have been able to use various means to hide non-performing assets.”
These new requirements, however, only apply to corporate loans and the government is continuing to push banks to lend more to risky small and private businesses to help reinvigorate the slowing economy. So, even with the stricter fines and regulations, the nation’s bad loan ratio is still expected to peak next year, according to the China Orient Asset Management Company.
China is often seen as something of a ‘testing ground’ by many Southeast Asian countries. Plus, due to sheer size and proximity, economic changes in China will often affect its closest neighbours - one more reason why banks in the region need to be taking note.
There’s a lot to be learned here. China proves that the key to progress when it comes to reducing bad debt (and its economic backlash) appears to be more substantial regulation, but it can only take you so far. Of course, China is very different from other Asian countries in terms of sheer size, might and political power, but there is still some transferable wisdom to be found in their firmer push for regulation and hard line on hidden debts.
More regulation isn’t necessarily the only answer, but in an area that’s so deliriously economically complicated (particularly when it comes to debt collections), a little more control might go a long way.
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