China’s official bad-loan ratio looks benign at 1.08 per cent, but few analysts believe that figure reflects the true magnitude of lenders’ asset-quality problems.
The share of non-performing loans in Chinese banks is almost certainly well below the officially acknowledged peak of 25 per cent reached in 1997, but estimates of the true ratio remain a topic of speculation.
The problem is that banks can employ a variety of methods to disguise their bad loans. The most common is simply to roll over debt. A bank that does not want to recognise a bad loan may offer a new loan to repay the maturing one.
“In situations where big borrowers are having problems repaying, the banks don’t want to make things worse by restricting liquidity, so they are finding ways to re-lend and extend,” says a senior bank adviser in China.
“Technically, it should not be do-able, but so much of the lending in recent years is considered political, so inspectors and regulators often allow leeway if they think the borrower is systemically important and could eventually get out of trouble.”
The International Monetary Fund says that a loan should be classified as non-performing if principal or interest are overdue for 90 days, or if overdue interest has been rolled over into a new loan.
Yet banks can skirt this requirement by leaving a gap of a few days between the old and the new loan. In such cases, a corporate borrower may access the high-interest informal lending market to raise cash to repay the maturing loan. After a few days, the bank issues a fresh loan that the borrower uses to repay the underground loan.
Annualised interest rates on informal loans can be 40 per cent or more, but the high rate is still manageable since many such loans are only for a few days.
Banks can also disguise bad loans by classifying them as “special mention”, a designation used for loans that are questionable but not yet non-performing. At Industrial and Commercial Bank of China, the country’s largest lender, Rmb231bn loans are classified as special mention, equal to 1.98 per cent of all loans and more than double the Rmb106bn labelled as non-performing.
Even if the official NPL figure understates the amount of bad loans, the trend is still indicative. The official NPL ratio is at its highest level since March 2011, and bank executives themselves say they expect it to keep climbing.