Bloomberg News

China Regulator Said to Tell Banks Loan Provision Inadequate

July 29, 2011

(Adds stock reaction in 13th paragraph.)

July 29 (Bloomberg) -- China’s banking regulator told lenders they haven’t set aside sufficient funds to cover losses on loans to local governments and ordered them to accelerate debt collection, a person with knowledge of the matter said.

The lenders were told this month that they are lagging behind the China Banking Regulatory Commission’s schedule for revising the loan agreements on infrastructure projects, the person said, declining to be named because the information is confidential. The agency had asked banks to collect two repayments a year after construction is completed.

The comments reflect persistent concerns that $1.7 trillion of lending to local governments may spur a wave of bad debts that could lead to the nation’s third banking bailout in less than two decades. As much of 30 percent of the credit may sour, Standard & Poor’s estimates, after a surge in lending that powered China’s recovery from the global financial crisis.

“The banking regulator is getting tougher on the local government debt risk, and that should to some extent increase the pressure on banks to boost their provisions,” said May Yan, a Hong Kong-based analyst at Barclays Capital Inc.

Efforts to curb risks in the loans have achieved “initial results, and the overall risk is controllable,” the regulator said in an e-mailed response to questions from Bloomberg. Going forward, banks should amend debt agreements, get better collateral and refine calculations on capital levels based on risk-weightings assigned to such loans, it said.

Underestimating Debt

China’s first audit of local government debt last month found liabilities of 10.7 trillion yuan ($1.7 trillion) at the end of 2010, 79 percent of which were bank loans. That estimate fell short of the actual figure by about 3.5 trillion yuan, Moody’s Investors Service said July 5, adding that lenders may be left to manage a portion of bad debt on their own.

Direct lending by banks to local government financing vehicles has surged over the past few years, from roughly 1.7 trillion yuan at the beginning of 2008 to about 4.97 trillion yuan at the end of 2010, Steve Wang, the Hong Kong-based head of fixed-income research at BOCI Securities, said July 26.

Much of the loan growth came amid a record $2.7 trillion two-year credit boom from the start of 2009 that drove China’s economic-stimulus program. The lending spree left the nation with almost $8 trillion in outstanding debt by the end of June, exceeding the combined size of China and India’s economies.

Potential Defaults

Loans to local government financing vehicles, set up mainly to fund infrastructure projects such as roads and airports, may sour and become the biggest contributor to banks’ bad debts, Liao Qiang, a Beijing-based director of financial institution ratings for S&P, said in April.

“Concerns over China’s local government financing vehicle loans have resurfaced in recent weeks,” analysts at UOB Kayhian Investment Co. led by Sheng Nan in Shanghai, wrote to clients July 25. “There have also been talks of local governments overvaluing the land used as collateral for their LGFV loans.”

Standard Chartered Plc, which gets more than half its income from Asia, estimates that at least 4 trillion yuan of the loans -- and possibly much more -- will ultimately not be repaid by cash flows generated by the infrastructure projects, according to a June 29 report.

Stocks Drop

Wang Zhenning, a press officer at Beijing-based Industrial & Commercial Bank of China Ltd., the world’s largest lender, declined to comment. Bank of China Ltd. said it doesn’t comment on market rumors, and China Construction Bank Corp. said it hasn’t received any information on the issue.

ICBC fell 2 percent to HK$5.84 as of 1:44 p.m. in Hong Kong trading, reversing earlier gains, and is headed for its biggest drop in almost three weeks. Bank of China dropped 1.9 percent, while Construction Bank tumbled 1.3 percent.

China has at least two years to sort out its mountain of local government debt, which poses a “very serious” risk for the world’s fastest-growing economy over the longer term, People’s Bank of China adviser Zhou Qiren said on July 23.

The central bank on July 11 became the second agency to dismiss speculation that local-government debt may be as much as 14 trillion yuan. The National Audit Office denied understating the liabilities, according to a report issued by the official Xinhua news agency earlier that day.

Still, the regulator is concerned that lenders haven’t moved fast enough to curtail risks, the person said.

Revising Loan Terms

The agency told lenders their reported bad loans are too low in comparison to the real risk, and their 1 percent provision coverage ratio for local government lending is unacceptable, the person said.

The banks, which were told to revise the loan accords by the end of May to ensure two scheduled payments by the borrower every year after the projects are completed, have ensured the desired terms on fewer than half of the loans, the person said.

About 17 percent of medium and long-term loans, which account for more than 90 percent of all local government credit, have failed to require paying down the principal until maturity, and almost 40 percent demand only one payment annually, the person said.

The repayment capacity of the local governments has been eroded as debt climbed to 116 percent of their revenue from 85 percent in early 2009 because of the government’s stimulus program, Mike Werner, an analyst at Sanford C. Bernstein & Co. in Hong Kong, said in a July 4 note.

“There will always be the risk that the CBRC may be forced to allow the larger banks to absorb some of the losses of the banking system,” Werner wrote. “Investors in the listed Chinese banks must deal with this overhang until the government arrives at a comprehensive solution.”

--John Liu, with assistance from Stephanie Tong in Hong Kong and Henry Sanderson in Beijing. Editors: Chitra Somayaji, Matthew Brooker

To contact Bloomberg News staff for this story: John Liu in Beijing at jliu42@bloomberg.net

To contact the editor responsible for this story: Chitra Somayaji at csomayaji@bloomberg.net


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