Moral hazard in debt-to-equity plan needs addressing
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.