China's large banks wary on govt's plan for bad loans

The Pak Banker - - COMPANIES/BOSS -

China's pro­posal to deal with a po­ten­tial bad-loan cri­sis by hav­ing banks con­vert their soured debt into eq­uity is meet­ing with un­ex­pected re­sis­tance from some of the big­gest po­ten­tial ben­e­fi­cia­ries of the plan -- the coun­try's large banks.

Asked about the plan at the Boao Fo­rum last week, China Con­struc­tion Bank Corp. Chair­man Wang Hongzhang said he needs to think of his share­hold­ers and wouldn't want to see a plan that sim­ply con­verted "bad debt into bad eq­uity."

China Citic Bank Corp.'s Vice Pres­i­dent Sun Deshun said at a press con­fer­ence last week that any com­pul­sory con­ver­sion of debt into eq­uity would have to be capped. And Bank of China Ltd. Chair­man Tian Guoli said in Boao that it's "hard to eval­u­ate" how ef­fec­tive debte­quity swaps will be, as so much has changed in China since the tool was used to bail out the bank­ing sys­tem dur­ing a pre­vi­ous cri­sis in the late 1990s.

Be­hind the cau­tion is a lack of clar­ity about how ex­actly the gov­ern­ment will pro­ceed with the con­ver­sion of up to 1.27 tril­lion yuan ($195 bil­lion) of bad debt owed to the banks mostly by the coun­try's lum­ber­ing state-owned en­ter­prises, and -cru­cially -- about the level of sup­port that will be avail­able from the state. Bank of Com­mu­ni­ca­tions Co., the first of China's large banks to re­port 2015 earn­ings, said Tues­day it nearly dou­bled its bad-debt pro­vi­sions in the fourth quar­ter of last year to 7.5 bil­lion yuan.

With­out back­ing from the gov­ern­ment, in the form of cash in­jec­tions or eas­ier cap­i­tal rules for the banks, any debte­quity swaps would sim­ply shift the bad­loan prob­lem from the SOEs to the banks, with po­ten­tially dis­as­trous con­se­quences for the sta­bil­ity of the na­tion's lenders. On the other hand it will be po­lit­i­cally im­pos­si­ble to re­peat the ap­proach used in 1999 and again in 2004, when Chi­nese tax­pay­ers ef­fec­tively un­der­wrote the bailouts, leav­ing the banks un­scathed.

"You can't kill three birds with one stone," said Mu Hua, a Guangzhou-based an­a­lyst at Guangfa Se­cu­ri­ties Co., re­fer­ring to the need to bal­ance the need to fix bank and SOE bad loans while pro­tect­ing the in­ter­ests of Chi­nese tax­pay­ers. "Vol­un­tary swaps won't scale up un­less the gov­ern­ment of­fers enough in­cen­tive, such as low­er­ing the risk weight­ing or set­ting up a plat­form for banks to dump the stakes."

The dis­cus­sion of debt-eq­uity swaps comes as China's pol­i­cy­mak­ers scram­ble for ways to cut cor­po­rate lever­age that has climbed to a record high, and to clean up the mount­ing tally of bad loans on the banks' books. Premier Li Ke­qiang said at the Na­tional Peo­ple's Congress ear­lier this month that the coun­try may use the swaps to cut the lever­age ra­tio of Chi­nese com­pa­nies and to mit­i­gate fi­nan­cial risks.

Un­der cur­rent reg­u­la­tions, banks face a puni­tive risk weight­ing of 1,250 per­cent for any eq­uity they hold in in­dus­trial or com­mer­cial com­pa­nies, though the amount of cap­i­tal they have to hold drops to 400 per­cent of the value of the as­sets if they ob­tain spe­cial ap­proval from the State Coun­cil. Even at the lower rate, it's well above the 250 per­cent weight­ing for bad loans, mean­ing that banks would have to raise large amounts of ex­tra cap­i­tal if they swap SOE debt for eq­uity on any scale.

"China banks' bal­ance sheets are not set up well to hold onto large amount of eq­ui­ties in in­dus­trial firms, which is why the CBRC is cau­tious and banks hardly hold any eq­ui­ties," said Matthew Smith, a Shang­hai-based an­a­lyst at Mac­quarie Group Ltd. "If that's the part one of a longer-term game to pro­vid­ing some relief to the dis­tressed bor­row­ers, the banks are not go­ing to end up hold­ing onto the swapped eq­uity. There has to be some plat­form to off­load this stuff."

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