China’s long march to financial health

Financially, China’s deleveraging is a fight against reckless lending and borrowing. Politically, it is a facet of Beijing’s push to centralise power, with such erstwhile mavericks as regional banks herded back into line. Tough new rules on the recognition of nonperforming loans reflect this. Damage to balance sheets is likely.

After the 2007 crisis China was flooded with cheap credit to keep the economy afloat. For a local businessman with good connections, this was an opportunity to build the skyscraper he always dreamt of. Some cases were less innocent: two-fifths of Bank of Liuzhou’s 2014 80-billion renminbi ($12bn) assets turned out to be fraudulent.

Loans assigned nonperforming status from less severe categories need to be backed up with more regulatory capital. About a quarter of the banks in a UBS study, covering nine-tenths of the commercial banking sector assets of 195-trillion renminbi, would fall below minimum provision levels. UBS estimates their total shortfall is about 250-billion renminbi.

Some banks will take a hit. Pretax profits at Huaxia Bank might have been a third lower in 2017 if the rules had already been in effect.

Does this mean regional banks will detonate the financial explosion long prophesied by China bears?

Thankfully, no. Crisis risks are manageable. The centre is sound even if the periphery is rotten. Big banks, such as China Construction Bank and ICBC, are barely affected by the nonperforming loan change.

In 2017, one type of risky interbank borrowing was replaced by central bank funds. Cutting out bad assets will take time. Greater state control is hardly a route to more efficient capital allocation.

Regional bank lending is only one fight in the battle. Similar questions apply to project funding through local government financing vehicles. Regional barons in business and the party face a wearying trek back to financial respectability. A long march, almost. London, July 6