The cash injections are designed to shore up the tattered balance sheets of these banking giants in preparation for planned listings on overseas stock markets over the next two years. A third bank, Industrial & Commercial Bank of China, is rumored to be in line to receive up to $40 billion later this year. "It's a drastic acceleration of banking reform," says Jun Ma, greater China economist at Deutsche Bank (DB
) in Hong Kong. "It looks like we are going to hear more news every week." Adds Hong Kong-based economist Jonathan Anderson of UBS (UBS
): "They are doing the right thing."
But are the capital infusions the first steps toward real reform and successful IPOs? Analysts say a healthy dose of skepticism is in order. For one thing, it's unclear if foreign investors will be clamoring for a piece of these turnaround stories. If other Chinese initial public offerings are a model, the banks will first be converted into joint stock companies and then a share float of about 25% would be sold overseas. What could scare off investors? Bad loans. Standard & Poor's (MHP
) estimates that total nonperforming loans in the financial sector add up to anywhere from $384 billion on the low end to as much as $864 billion. A workout of the bad debt could cost some $600 billion, experts say, which is 40% of China's $1.4 trillion gross domestic product.
The bailouts are no silver bullet. They won't do anything to reduce bad loans per se, because the new money is in the form of U.S. dollar-denominated exchange reserves from the central bank, not Chinese currency. The reserves simply make the balance sheets appear stronger so the banks can write off more loans without shrinking their capital base. While the bailouts will bring capital adequacy ratios, currently 4% to 6%, closer to the international norm of 8%, tackling bad loans will require a new level of commitment from bank management. "The money is just one component of the overhaul," says Ping Chew, S&P's director of sovereign ratings in Singapore. "More important is management and how they manage their risks."
Years of politically directed lending -- mostly to shore up money-losing state-owned enterprises -- a virtual absence of credit-risk management, and shoddy bookkeeping practices by both banks and their customers have allowed nonperforming loans to grow steadily. Agricultural Bank of China, with an official ratio of bad loans to overall loans of about 32%, is in the worst shape. At the same time, more than $1 trillion in bank savings by China's frugal citizens, attractive interest rates, and high demand for loans have ignited an explosion of new lending in recent years. As a result, operating profits at the banks are high and nonperforming loans are actually declining as a percentage of overall lending (chart). Money supply and loans both grew by about 20% in 2003. With scant evidence of any marked improvements in due diligence, however, many of the new loans may also go sour.
Because it typically takes time for problem loans to surface, it could be several years before these start to turn bad. But already concerns are growing that much of the lending is being squandered on projects that will earn low -- or no -- return. For instance, economists have been warning of plant overcapacity in the ever-expanding automobile, aluminum, and steel manufacturing industries, which are building out with the help of bank loans. But changing China's loose credit culture won't be easy. "It takes years, even generations, to change," says Citigroup Smith Barney (C
) China economist Yiping Huang.IFFY RESULTS. And there's plenty of evidence that previous bailouts haven't forced banks to restructure themselves. In 1998 and 1999 the government created four autonomous asset-management companies and transferred some $170 billion worth of bad loans to them from the Big Four banks. It also injected $32 billion in fresh capital into the banks. At the time, this was billed by the government as the mother of all bailouts. But as S&P's Chew points out, "it didn't work as perfectly as envisioned, or the government wouldn't be putting more money in now."
Moreover, the new asset-management companies haven't had an easy time turning their bad debt into cash. At the end of 2002, they had recovered just $8.1 billion on delinquent loans with a face value of $36 billion. Part of that return came from auctions to foreign investors such as Morgan Stanley (MWD
), which snapped up $1.3 billion worth of loans for cents on the dollar at an auction in 2001 -- though it didn't actually win approval to pay for them until last July. Goldman, Sachs & Co. (GS
) bought $270 million worth in February, 2003. And in an auction in December, J.P. Morgan Chase & Co. (JPM
) and Citigroup (C
) also bought up an unspecified amount of debt. Yet it has been slow going for these white-shoe debt collectors. Though none will disclose the profitability of its operations, an executive at one of the foreign banks admitted that "nobody is making any money in this game in China."
Still, there's reason for optimism if China's banks demonstrate they are capable of reforming overly generous lending and collection policies. In one of the most promising signs yet, a banking watchdog was created last April to oversee the transformation of the industry. The China Banking Regulatory Commission took oversight duties from People's Bank of China, thereby eliminating the conflict of interest in which the banking system's chief advocate was also its regulator. Heading up the new body is Liu Mingkang, a highly respected former head of Bank of China who oversaw the Hong Kong listing of its overseas operations. Since Liu took the helm, the CBRC has mandated stricter classification of bad loans and quarterly reporting of problem loans. "I'm very impressed," says Wei Christianson, China country manager of Credit Suisse First Boston (CSR
). "He's very seasoned and brings a wealth of experience to the job."
With Liu pushing the banks hard to clean up, they might well be able to exploit the white-hot market for China IPOs. They're also being pushed by the clock, which is fast running out on their protected status. China's commitment to the World Trade Organization to open its banking system to foreign competition by 2007 means that it's now or never for the banks to turn the page on the days when they served as mere cogs in a state-planned economy. The Year of the Monkey could well be auspicious for China's banking quartet. By Frederik Balfour in Hong Kong