Chinese banking problems, again

Interesting piece in today's WSJ Asia edition, detailing the way in which the Chinese regulatory agencies are trying to balance control on credit growth and off-balance sheet structures in the banking industry with softening the blow to the banks in the aftermath of the monster stimulus efforts.  Like always in China's case, the stimulus was executed in 'public-private' fashion, with the 'private' end -- the banks -- doing precisely what was required of them: lending big-time to local authorities and special purpose entities created to pump liquidity into the system nationwide.  This was remarkably successful.  But as with the round of 'privatised debt' to the state-owned enterprises of a decade ago, this will leave an NPL hangover of substantial proportions for the banks.  The CBRC and their political masters no doubt feel that a measure of regulatory forbearance is in order.  S&P, however, are unhappy about this.  The current situation is an interesting illustration of the tensions implicit in increasing openness in the banking sector, adherence to international standards whilst the system as a whole is still heavily guided by a not-so-invisible hand.

-Jan Cherim

Here is the full article from the WSJ's Dinny McMahon:

13 Jan 2012 07:40 CST China Acts Against Credit Risk --- Beijing Takes a Step to Keep Banks From Moving Commercial Paper Off Balance Sheet ---- By Dinny McMahon

BEIJING -- China's banking regulator took new steps to clamp down on risks in the financial sector, even as a report from Standard & Poor's said political considerations might force authorities to grant banks some leeway on loans to local governments. The China Banking Regulatory Commission on Thursday said it has told trust companies, which are lightly regulated investment vehicles, to stop selling investment products backed by commercial paper held by banks. The products allow banks to move the commercial paper -- a type of short-term financing for companies -- off their balance sheets, freeing the banks to increase the amount they lend even though they are still on the hook if the loans turn sour. Analysts say the total amount of these investment products is still modest, but the regulator is acting pre-emptively to prevent them from growing large enough to create potential instability. Analysts say Beijing, after spending much of the past year trying to bring prices under control, is likely wary of allowing banks to buck credit controls, even though inflation is falling. Data on Thursday showed consumer prices rose 4.1% in December from a year earlier, down from 4.2% in November. A report from rating firm Standard & Poor's Ratings Services, also issued Thursday, said regulators will likely allow banks to postpone recognition of losses on some local-government loans. While that might make a cosmetic improvement to bank finances in the short term, it could result in greater losses down the road and harm the sector's reputation, the report said. Starting in 2008, China's stimulus efforts in the face of the global financial crisis were led by the banks, with much of their new lending going to companies set up by local governments to help fund infrastructure investment. Since then, the banking regulator has been working to shore up the banks' capital base, repeatedly bumping up the amount of capital they need to hold on their books and trying to ensure that the banks are properly accounting for their risks. According to the S&P report, the political need to keep cash-strapped local governments afloat is now likely to trump the CBRC's commitment to scrutiny. "In the short term, extending the debt maturities to facilitate payments would . . . avoid a surge in nonperforming loans," the report said. "But it is also likely to undermine investors' confidence for some time to come . . . and highlight the CBRC's lack of independence from the government." Saying the move would be a "backward step," S&P estimated that such forbearance could reduce local banks' credit losses by as much as 80 billion yuan to 100 billion yuan ($12.7 billion to $15.8 billion) per year, assuming Beijing relaxes its standard for the next three years. The National Audit Office estimated last year that China's local-government debt totaled 10.7 trillion yuan -- the equivalent of 27% of 2010's gross domestic product. S&P estimates that about 30% of loans made to local-government financing companies could go bad over the next three years in the absence of public support. S&P's managing director for financial-institution rating in the Asian-Pacific region, Ryan Tsang, said he "can't say for sure" whether Beijing will go ahead with the regulatory relaxation, but that it is likely. The CBRC declined to comment on the S&P report. Meanwhile, the crackdown on trust products signals the regulator is unlikely to loosen its efforts to bring the informal lending sector under control. The move to stop trust companies from selling commercial paper is the latest effort by the regulator to ensure that risks don't start accumulating in the financial system without proper oversight. "At the end of the day it's a bank liability," said Standard Chartered economist Stephen Green about commercial paper. Trust companies occupy an unusual niche in China's financial sector. Less tightly regulated than other institutions, they operate more like hedge funds than anything typically labeled a trust in other countries. The trusts typically raise funds from wealthy individuals that they invest in many ways, including leasing, real-estate purchases and private-equity investments. The regulator last year cracked down on banks using trust companies to move ordinary loans off their books, requiring them to bring all loans packaged as trust products back onto their books by the end of 2011. "Trust companies then started looking for other ways to continue the business that wasn't expressly prohibited by the regulator," said Ivan Shi, senior associate with Z-Ben Advisors, a Shanghai-based consulting firm that tracks investment companies. He said the result was a shift into commercial paper. --- Natasha Brereton-Fukui, Rose Yu, Wang Ming and Eliot Gao contributed to this article.