Arthur Kroeber at FT’s Dragonbeat blog has a fascinating post about China’s history of dealing with non-performing loans on bank balance sheets.
Historically, the strategy has been to quietly sweep them off bank books, finance them in their own “Super-SIV” if you will, and then hope that economic growth ends up diminishing the significance of them. And so far this has worked handsomely. The first time they tried this stunt, in 1999, the bad debt amounted to 18% of GDP. Today that’s only 4% of GDP — far more manageable.
But you can only keep sweeping things under the rug so many times.
Indeed, the bet has paid off so handsomely that CCB’s decision to roll over an Rmb247bn bond from Cinda Asset Management Co for another decade looks set to be followed by the other big banks.
Will the bet pay off again – or have officials simply set the timer on a financial time-bomb and decided that someone else will be in the room when it explodes?
To begin estimating the full cost of writing down China’s NPLs in 2019, we assume that recoveries on NPL Tranche 1 are 15 per cent, which the distressed assets specialists tell us is reasonable.
For Tranche 2, 72 per cent has already been written off. We assume no further recoveries on the outstanding balance of Rmb348bn, all of which seems to have been financed by the central bank.
For Tranche 3, we assume a recovery rate of 15 per cent – but this may be too optimistic. To balance that out, we make a very aggressive estimate for Tranche 4, assuming that one-sixth of the Rmb20,000bn in bank loans likely to be issued in the three years 2008-2010 will go sour.
This is bold: it means that China will have to deal with an as-yet unrecognised NPL liability of Rmb3,300bn, almost equal to the face value of all NPLs hitherto recognised (Rmb3,500bn).