Moral hazard in debt-to-equity plan needs ad­dress­ing

China Daily (Canada) - - LIFE -

China is re­port­edly con­sid­er­ing a plan for debt-to-equity swaps, which are de­signed to bail out debt-rid­den firms amid the eco­nomic down­turn and pre­vent the non-per­form­ing loans of banks from rapidly pil­ing up.

It is a stop­gap mea­sure, but one that, if it works well, will im­prove the op­er­a­tional ef­fi­ciency of both en­ter­pris­esand­banks. How­ever, de­tailed, ap­pli­ca­ble im­ple­men­ta­tion poli­cies­mustbe put in place to en­sure the­p­ro­gram­does not go awry.

Pol­i­cy­mak­ersmusthave been en­cour­aged by the pre­vi­ous equity-for-debt pro­gram, ini­ti­ated at theendof the 1990s, in which­many in­sol­vent State-owned en­ter­prises were saved from go­ing bank­rupt.

In­deed, in the best-case sce­nario, such a schemewil­l­have anum­berof po­ten­tial ben­e­fits. Com­pa­ni­es­can­have their debt bur­dens re­ducedandim­prove their bal­ance sheets so they can bor­row­more­from banks, makin­git pos­si­ble forthemto step out of dif­fi­cul­tieswhen­themacroe­co­nomic sit­u­a­tion im­proves.

For the banks, their loan­book­swill look bet­ter. As their non-per­form­ing loan ra­tio iskept­from­ris­ing, they­woul­dal­sobe­come will­ing to ex­tend­newloans to the cor­po­rate sec­tor, whichis cru­cial con­sid­er­ing China’s frag­ile eco­nomic fun­da­men­tals.

For the fi­nan­cial mar­kets, the ris­ing bad loans of banks would deal a heavy blow to in­vestors, lead­ing to mar­ket tur­bu­lences.

And for the gov­ern­ment, such a pro­gram can pre­vent mass bank­rupt­cies and lay-offs— which af­fect so­cial sta­bil­ity— from oc­cur­ring.

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