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Third Plenum Report Shows Hope in Restructuring China’s Financial System and Lowering the Country’s High NPLs

11/22/2013

 
After years of struggling with rising non-performing loans (NPLs) and after multiple policies by China’s central bank to mitigate the issues, NPLs are continuing to rise due to large steel trades and solar-panel manufactures whose loans are near collapse, in addition to the fact that asset management companies are growing their influence in the country’s financial services sector. But the report that came from the Third Plenum report last Friday showed hope in rebalancing the financial system.  

Chinese banks' non-performing loan ratio rose slightly to 0.97% at the end of September from 0.96% a quarter earlier, the China Bank Regulatory Commission said last week. NPLs loans totaled 563.6 billion RMB ($92.5 billion) at the end of third quarter, compared with 539.5 billion RMB at the end of June.

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The capital adequacy ratio of Chinese banks stood at 12.24% at the end of June. In 2012, China’s NPLs rose by 64.7 billion RMB ($10.4 billion) to reach a total of 492.9 billion RMB ($80 billion), though the ratio of bad loans to good ones stayed steady at 0.95%. More recently, at the end of last March, NPLs totaled 524.3 billion RMB ($84.8 billion), which was up more than 20% year-on-year, and 33.9 billion RMB from the start of 2012..

The Chinese banking regulator is planning on raising the proportion of a bank's equity capital and retained profits against its risky assets--or the capital adequacy ratio--for large banks to at least 11.5% and for smaller ones to 10.5% by 2018. This is not the first time China’s regulator as taken action to slow down the growth of rising bad loans. More than a decade ago, Beijing established four state-funded asset management companies to take over the bad debts of the four biggest state-owned banks.

Despite the fact the Chinese government has been consistently attempting to mitigate its banking NPL issues, the bank’s NPLs continue to grow and many, including our researchers at Q Intel Research, believe that the NPL ratio among banks are much higher than the figures that Chinese central bank has been reporting. We believe that the NPL ratio could be much worse if off balance sheet exposure - such as from wealth management products and corporate bonds--is taken into account. China Citic Bank and China Minsheng Bank had a lot of exposure to off balance sheet loans, which believe account for an estimated 30-40% of their reported assets. Clearly official NPL figures underestimate the severity of bad loans, but calculating the exact numbers of the true NPL ratios in Chinese banks are difficult as they are taken off the balance sheet and placed into investment and trust vehicles.
 
Although there are a variety of theories being discussed between financial analysts and China observers, we believe that there are three main reasons that have continued to continue to keep Chinese NPLs high to the point it has become structured. The first reason we see is that China’s economic stimulus of 2008 of nearly 4 trillion Rmb ($ 586 billion) in addition to the government’s future indirect stimulus in real estate projects and infrastructure has created overcapacity in many Chinese industries, which has caused many of these companies to not be able to pay back their loans as the European and American economy continue to require less exports than they did before the 2008 crisis.
 
Another main reason we are seeing for China’s unchecked fixed capital formation and poor investments by banks. This can be seen in China’s continues to support inefficient companies who have few ways to pay back their loans, and to continue to invest in projects for the sake of government growth. This comes to our third point of local government’s dependence on low-interest loans. Local governments throughout China depend on low-interest rate loans from Chinese banks to meet their GDP targets. The issues appear to be structural as they are linked to ensuring economic growth and stability in a critical time in China’s political sphere.

The only way for Chinese banks to break out of its NPL problems that it has been dealing with for years is for structural, financial reform. The Third Plenum that just ended with a significant report that outlined many reforms that should in time rebalance China’s economy and get its financial system back on track. We believe the main reforms that were presented in the plan that will permanently decrease China’s steady high NPL ratios are the following.



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