Shoring up China’s banks

The Chinese government revealed this week that it had completed the first phase of a second re-capitalization of its four biggest state banks in an attempt to prop them up against their exposure to about billion of non-performing loans. The banks badly need the capital injections—which are in the form of loans drawn on China’s $400 billion hard currency (foreign) reserves—to raise their capitalization ratios above the curent 8 percent minimum “recommended(link to BIS website)”:http://www.bis.org/bcbs/aboutbcbs.htm by the BIS. The state banks represent 60% of lending in China. Even if they comply with the conditions apparently attached to the loans, their shaky condition remains a major risk for the economy. According to “press reports(link to Financial Times story)”:http://www.ft.com/servlet/ContentServer?pagename=FT.com/StoryFT/FullStory&c=StoryFT&cid=1073281063652&p=1012571727102 the billion already divided between the Bank of China and the China Construction Bank come with several conditions related to governance including criterial for future performance by both the banks and senior staff. The Agricultural Bank and the Commercial Bank of China are next in line for similar capital injections. In 1999 the Chinese government put billion into the crumbling banks and directly reduced some $170 billion in bad loans.  Assuming that the total injection this time is about $100 billion, it represents less than half the official level of exposure to bad debt. The raid on foreign reserves to fund the transfers means that the Chinese authorities have weakened the case for a Renminbi revaluation at the same time as shoring up the banking sector. But they’ve used real money: will they get value? Even with these massive transfers, history suggests it would take extraordinary efforts to manage the banks back to profitability and good performance. Similar bail-outs of the Japanese banks in the late 1990s didn’t work. Also, given China’s very high rate of growth and the past performance of the banks, it’s very likely that the banks continued to use the last funds injections to lend to “risky commercial ventures(link to NY Times story on China’s investment bubble)”:http://www.nytimes.com/2004/01/18/business/yourmoney/18china.html. Both the Bank of China and the China Commercial Bank are scheduled to list on the HongKong stock market next year.

Resource

An excellent overview of (among other things) the risks for the Chinese economy of the underperforming state sector, and the consolidation of those risks in the accounts of the state banks, can be found in “China Embraces the World Market(link to DFAT East Asia Analytical Unit)”:http://www.dfat.gov.au/publications/catalogue/china_embraces_world_market.html, avaiable for download from the Australian Department of Foreign Affairs and Trade.

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