Chinese Banks in Trouble? Over Overstated Statistics? You Decide

Sunday, December 21, 2008 0:00
Posted in category Uncategorized

Through the recent turmoil has come a lot of speculation about the moves China will make, and what the impact of those actions will be.  Externally, there are those who are looking to China to push consumers to spend their war chest of savings in an effort to realign the balance.  Others have the view that China’s government should spend its own 2 trillion USD reserve.

Both have their merits and both would certainly have their consequences long term.

To date, what has been done has largely been measured.  We have sen the RMB pull back a bit recently, a few targeted industries have seen their VAT rebates increased, and the government has pulled together a stimulus plan that will put millions to work on China’s infrastructure.

For 2 of the most prominent China focused economists, Victor Shih and Jon Anderson, the recent moves made on the policy side have given them the opportunity to write pieces on the more long term effects of policies on the banking sector.  The analysis of both is interesting in that they both see the same steps occuring in many ways, but their end analysis is quite different.

Victor’s positions
In the recent WSJ piece (subscription required) Chinese Banks’ Great Leap Backward Victor lays out his argument in the opening paragraph:

In particular, Chinese banks are currently under enormous pressure to change their business practices in ways that represent a serious step backward.


risk-prevention institutions built up over the past decade are now under enormous pressure to forgo prudence in the interest of maintaining economic growth. There have been two triggers for this. First, the global recession caused a plunge in demand for Chinese goods — in November, Chinese exports fell for the first time in nearly a decade. At the same time, the property market continues to shrink in many major Chinese cities.

which will spell trouble for China’s bank industry, and on a wider level China’s economy.

Jon Anderson’s position
In his most recent release Four Myths about Chinese Banks, Jon lays opens his case for why he feels fears are overstated with the following:

To begin with, there is no lack of spending capacity in the general government
accounts themselves; with extremely low public debt levels and a cash surplus on a flow basis,
the government could increase its own expenditure by a sizable share without taxing markets

and closes his argument with:

Which brings us to the final point: even if we were to assume that the entire additional 1% of GDP worth of financing came from commercial banks, and that a significant portion of this lending turned bad – strong assumptions on both counts – this would still imply a rise of only half a percentage point in the overall commercial bank NPL ratio.

so, in Jon’s argument, even with the added pressure of these loans, the risk of a wider failure are minimal and should not be feared.

My position
Personally, I am leaning more toward Victor on this one, and I am not 100% sure that I can swallow the pill whole that Jon’s report offers.

The underlying logic and statistics that show how much progress has been made in the banking industry are well presented and follow a line that I would generally agree with – and that Victor’s position supports as well.

However, where I tend to take a more concerned view is that there are a number of historical concerns that I cannot dismiss that lead me to believe that it is not as simple as Jon’s research suggests:

The NPL ratio is essentially bad debt/ total debt, and when the ration was going from 40% to 6%, many were question the real causes of this fall
– was it the government bailout?
– was it the denominator blowing up?
– was it banks reclassifying chunks 0f the numerator?
– was it that banks were offloading the numerator onto the asset management firms?
– was it that banks were really improving their credit practices?

Why knowing the real answers, and addressing the underlying issues is important is that many at the time believed that while many banks were improving, the main reasons for the ratio drop was that banks were blowing out the denominators by issuing new loans. It was when real estate was hot, and the new loans were effectively diluting the ratio.

At the same time, loans that were being offloaded to the AMCs were helping to clean up the individual banks, but taking a system wide view little had changed. All the banks and AMCs are under the PBOC regardless, so really this action (if the assets went unresolved) was little more than moving the problem to a balance sheet held by a different business unit yet still help by the parent.

Were the practices really changing, and to be clear – leaders in these banks were working hard on this one, then perhaps Jon’s argument has more credibility as fewer new loans would end up bad. Where I am having trouble here is that Bank of China/ Ag/ ICBC/ CCB operated thousand s of branches that are in many ways loose networks of affilliated banks. Typically computer systems are not in line, and it is difficult for national policies to filter out locally due to local fiefdoms looking out for themselves.

Where does that leave us?

My gut feeling is that the current picture of the NPLs in China is still largely unaccounted for. Many of the loans that were put into the system over the last 5 years are better than their predecessors, but those who believe that the real NPL ratio is at or below 6% are missing something somewhere – or that like trade statistics – the statistics being used are themselves unable to account for the full picture.

China’s banking system is one that is still far from mature, and were it not for the fact that China’s citizens are amazing savers, it would have gone bankrupt years ago

I think that Victor’s concerns that some areas of risk management will take some steps back as the political pressure increases.

Will it wreck the banking system in the short term? I don’t think so. However, as we have seen in the American banking system, we should be thinking about the long term, and regardless of whether or not the Chinese government has the money to capitalize the banks should they need it, the banks need to put into place ( and maintain) practices that create a structure that wouldn’t need that capitalization.

Note: Due to the WSJ and UBS legal departments I cannot post their articles in full.  If you would like either, I have both and can email to you directly on an individual basis.

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3 Responses to “Chinese Banks in Trouble? Over Overstated Statistics? You Decide”

  1. Duncan says:

    December 21st, 2008 at 4:52 am

    There’s some good arguments both ways on this one. Like you I lean towards Victor’s position in pointing out the negatives of the stimulus package for banks, but I also feel Jon’s line that essentially this is not a major problem/priority in the current circumstances is pretty sound. One of the key issues seems to be whether you regard the current level of bad loans as problematic. The rate of 6% or so is still high by international standards and is likely to be a cyclical low, coming as it does off the back of a surge in total lending into a boom market. And that’s without including the “special mention” loan category that I believe is another 10% or so. Still, the government has got that huge pile of reserves to keep throwing around for a while yet…

  2. Clement Wan says:

    December 21st, 2008 at 6:54 am

    I think it comes down to both incentives and internal banking culture – so I side with Victor Shih. I’ve heard from people that the government influence has never really gone away, but let’s say it had been moderated (and almost eliminated), the danger that Mr. Shih refers to is not these immediate amounts but those going forward and that may not require significant amounts of money for banks to revert (ie if government officials realize how easy it is to influence/direct lending now – themselves under the influence of er, rent-seeking, why wouldn’t they again try it in the future possibly on a more individual basis?). Personally, I’m pretty skeptical about that 6% number to begin with – not to mention a lot of other government reporting related to inflation and GDP.


    PS. I believe that all of WSJ’s opinion articles are available for free and without registration (though not sure about this one since it was specifically in the Asian edition only), but if it’s not, his article can also be found on his blog here:

  3. Clement Wan says:

    December 21st, 2008 at 11:27 am

    Very marginally related is this article that you may find of interest: