Six years after the government bailed out U.S. banks and auto companies, Chinese regulators are coming up with strategies to clean up their own banks’ bad debts, primarily caused by loans to state-owned enterprises that have suffered from persistent overcapacity.
Chinese authorities worry that, in shifting from these historically favored industrial companies to service industries, the country could incur bankruptcies, unemployment and debt write-offs. Chinese Premier Li Keqiang has said repeatedly that the downsizing of the steel, coal and other industries would occur without large-scale layoffs.
According to the National Bureau of Statistics, from 2005-2014, the manufacturing composition of China’s economy declined from 47 percent to 43 percent, while its service companies rose from 42 percent to 48 percent.
Corporate debt now amounts to 160 percent of China’s gross domestic product, according to Standard & Poor’s Ratings Services. That compares with a current U.S. debt level of 70 percent.
Nonperforming loans have increased in part because of a sharp decline in profitability resulting from China’s slowing growth. Many banks have extended new credit to these state-owned enterprises to repay existing debt and make their books look healthier.
The size of the Chinese bad-debt problem could be enormous. Kyle Bass, the founder of Dallas-based Hayman Capital, estimated in a Feb. 16 letter to his investors that the country’s bad loans total $5.5 trillion, some 400 percent more than U.S. banks sustained during the subprime mortgage crisis.
Bass wrote: “Similar to the U.S. banking system in its approach to the global financial crisis, China’s banking system has increasingly pursued excessive leverage, regulatory arbitrage and irresponsible risk taking.”
In recent weeks, Chinese regulators have outlined steps to help their banks shed bad loans, despite concerns about their effectiveness.
A main component of this effort would allow banks to sell non-performing loans to investors, either by securitizing them or transferring them to special asset-management companies that handle distressed debt.
Shang Fulin, chairman of the China Banking Regulatory Commission, said: “Through securitization and transfers of nonperforming assets, the hope is to increase the turnover rate of bank lending, thereby improving [banks’] ability to support the real economy.”
Zhou Xiaochuan, China’s central bank governor, said that such securities could attract investors who specialize in buying troubled assets, but he stressed the need to draw lessons from the 2008 global financial crisis in developing the market.
On Feb. 25, Reuters reported that the six largest Chinese banks have been selected for a trial run of securitizing billions of dollars of loans. Only if these measures are effective will other banks be allowed to participate in the program.
China’s banking rules forbid commercial banks from taking stakes in nonfinancial entities. But the state-owned Assets Supervision and Administration Commission is pushing for changes in the rules to help heavily indebted state companies.
In the 1990s, China dumped bad debts into specialized asset managers, also owned by the state. Those asset managers have since grown into massive operations.
In a World Bank publication, “East Asia & Pacific on the Rise,” author Gao Xu discussed the importance of state-owned enterprises in the Chinese economy. China’s economic policies stem from the high percentage of the economy controlled by these state-owned enterprises.
As of 2010, these organizations control 30 percent of the total secondary and tertiary assets and more than 50 percent of total industrial assets. The average size of SOEs is more than 13 times larger than their non-SOE peers.
Deng Xiaoping, paramount leader of China from 1978 to 1992, tried to reduce the monopoly of state-owned enterprises in the Chinese economy. His encouragement of private enterprise led to China’s economic miracle. But since the communist takeover of China in 1948, the government’s top-down economic policy has favored special interests.
While Deng encouraged private enterprise, state-owned enterprises remained outsized.
Deng famously said, “It doesn’t matter whether a cat is white or black, as long as it catches mice.” His primary concern was whether a business was efficient and capable of doing a job.
Today’s Chinese leaders need to learn that a fat cat can never catch a mouse!
Originally published in the Sarasota Herald-Tribune
