The European and American financial systems both have obvious problems, but a lot of them are at least known these days.
It’s thus China’s financial system which remains the real question mark.
Due to a lack of transparency, and the fact that things haven’t unravelled so far, it’s extremely unclear to what extent Chinese banks are sitting on bad loans which either won’t be repaid in full or are simply worthless.
Yet the latest chatter isn’t sounding good:
Chinese banks may struggle to recoup about 23 per cent of the 7.7 trillion yuan ($1.1 trillion) they’ve lent to finance local government infrastructure projects, according to a person with knowledge of data collected by the nation’s regulator.
About half of all loans need to be serviced by secondary sources including guarantors because the ventures can’t generate sufficient revenue, the person said, declining to be identified because the information is confidential. The China Banking Regulatory Commission has told banks to write off non-performing project loans by the end of this year, the person said.
Local governments set up the financing vehicles to fund projects such as highways and airports due to limits on their ability to directly borrow money. The central government this year restricted borrowing on concern money isn’t being used for viable projects.
Only 27 per cent of the loans to the financing vehicles can be repaid in full by cash generated by the projects they funded, the person said.
Given that banks operate with leverage, whereby a small equity base supports a far larger asset base, even 10% overall loan losses can be grievous. For a very basic example, imagine a bank who has equity equal to 10% of total loan assets, 10-1 leverage. If 10% of the loans are worthless, all the equity is wiped out in this over-simplified example. That’s why the percentage figures mentioned above are enormous.
The only saving grace here is that many of these bad bank loans are already considered the equivalent of transfer payments to local governments, since loans that aren’t expected to be paid are basically money transfers.
In this light, the Chinese Banking Regulatory Commission already knows there’s a problem and has told banks to write-off their bad loans by the end of this year. Banks have already begun raising capital to make up for potential loan losses, which is why we saw the giant IPO of Agricultural Bank at the beginning of July.
Still, the threat is that the quantity of bad loans is far larger than the government can deal with.
(Tip via Zero Hedge)