Hidden Bad Loans in Chinese Banks Raising Ponzi Risk

Hidden Bad Loans Raising Ponzi Risk

05-21 17:19 Caijing

Interest arbitrage practices, which constitute a self-loop within the financial sector, are likely to weaken the links between finance and the real economy and negatively impact the real economy.

By staff reporters Wang Peicheng, Dong Yuxiao, and You Xi

Official statistics show that the banking industry in China had 526.5 billion yuan worth of non-performing loans and a bad loan ratio of 0.96 percent by the end of the first quarter of 2013, which represents a 0.01 percent increase in the bad loan ratio since the end of 2012. However, the ratio is still below general expectations, given the slow and zigzagging growth in the real economy.

The real condition is far more serious than that reflected on financial reports, as are the potential risks in certain areas. “There is no point trying to gauge the actual risks facing the domestic banking industry with the bad loan ratio,” said an official at the China Banking Regulatory Commission (CBRC).Caijing learned that large amounts of bad assets were hidden by domestic banks attempting to window-dress their financial reports. Meanwhile, local government financing vehicles (LGFVs) and large enterprises have turned to non-banking channels for new credit to repay or roll over their bank loans, which has led to the spread of debt risks beyond the banking sector as well as a decrease in the overall capital efficiency.

Over the first four months of 2013, the total amount of social financing in China rose 3.06 trillion yuan to 7.91 trillion yuan, logging a 39 percent increase year-on-year. However, much of the money did not enter the real economy. Data from the National Bureau of Statistics (NBS) indicate that China’s gross domestic product (GDP) grew 7.7 percent year-on-year for the first quarter of 2013, which is significantly lower than market expectations.

Moreover, the Producer Price Index (PPI) dropped 2.6 percent year-on-year in April to a record low unseen since last November, which forebodes a lack of economic momentum and sluggish growth going forward.

A source close to the monetary authority listed four reasons why statistics from China’s financial sector seem out of sync with the performance of the country’s real economy: one, the NBS overestimated the economic data for the fourth quarter of 2012, and certain financial figures such as the amount of entrusted loans were inflated for the first quarter of 2013; two, the allocation of financial resources has become less efficient in that a large proportion of funds has been invested in the real estate industry and LGFVs; three, the lag of monetary policy has widened as enterprises cut back on their capacities; and four, the impact of exchange rates, e.g. the yuan has appreciated while the yen has depreciated recently.

A wide disparity between the total amount of social financing, which by definition is the overall financing the real sector has acquired from the financial sector, and the overall financing the real economy actually needed or has received highlights the closed circulation of money within the financial sector.

The seemingly complex interest arbitrage activities, which to some extent constitute a self-loop within the financial sector, are likely to weaken the links between finance and the real economy and negatively impact the real economy, for instance by causing an asset bubble or draining the real economy of funds it needs for development, said Zeng Gang, director of the Department of Banking Industry at the Institute of Finance and Banking, Chinese Academy of Social Sciences.

When enterprises put a large proportion of social financing into repaying debt, they could easily fall into a debt trap given a weak recovery in the real economy. The source at the CBRC contends that the practice of repaying old debts with new borrowing could turn into a Ponzi scheme and multiply systemic risks in the financial industry when the return on investment fails to cover debts payable.