China’s Banks Accelerate Bad-Loan Write-Offs

THE BOND DEFAULTS and bank runs seen in recent weeks are small beer when it comes to signs of stress faults in China’s financial system. Far more concerning is the rapidly rising volumes of loans turned sour that the country’s big banks have been writing off.

China’s five biggest banks — which account for more than half of all loans written — wrote off 59 billion yuan ($9.5 billion) of bad debt, according to their 2013 results, the Financial Times reports. That was up 127% from the previous year’s write-offs and the most since the big-state-owed banks had to be cleaned up and recapitalized a decade or so back. A slowing economy and authorities efforts to reign in shadow banking are making it more arduous for borrowers to repay debt.

The big banks have been required by authorities to build up a plump cushion of reserves to absorb bad loans such as these, and to absorb those that offer any hint of defaults that pose the remotest systemic risk. One of the benefits of the measured pace of financial reform is that the big bank’s profits, though growing more slowly than previously, remain healthy despite having to hold higher capital reserves.

The banks’ reported ratio of bad loans to total loans remains a comfortable looking 1% for last year, up from 0.95% in 2012. That prompts two questions: first, to what extent are write-offs being used to massage that number; and second, how accurate are the banks’ reported non-performing loans numbers? Some suggest the true number could be five times as large.

As the credit rating agency, Standard & Poor’s, recently noted, loan quality will likely decline further in 2014. Banks remain at risk from debt-laden local government financing vehicles, a weakening real estate market, and earnings-challenged manufacturers for whom a slowing economy is only exacerbates the ill-effects of the excess capacity they borrowed to build. And if the leadership holds to accepting slower growth as one of the cost of economic reform to rebalance the economy, these strains on the financial system are likely to continue well into 2015, too.