[Brief] The uneasy nonperforming loans in China may be the trigger for the next Asian financial crisis

Chinese banks may have reported lower nonperforming loan figures than expected. But what lies beneath could be a complicated system that hides the risks of a weakening financial system.

Editorial 

Everyone is pretending not to see it, but the Chinese market has been unstable in recent years. Analysts have been sceptical about the reported low non-performing loan ratios “NPL” in recent years.

The NPL of listed Chinese banks for 2016 remained below 1.6%. While NPL increased over the last 5 years, Chinese NPLs were consistently healthier relative to other emerging nations.

For the year 2016, China’s reported NPL was lower than Singapore. Many questions if the relatively low NPL levels resulted from reclassification of loans as special mention loans. Under the latter classification, special mention loans required fewer provisions than NPLs.

However, these classifications only mask the truth. In recession, these loans will default regardless of their classification. By then, listed banks will have to announce special provisions resulting in aggressively allowances and losses, unexpected.

The challenge is how Xi’s administration will handle this situation. As the central government combats outflow of capital and attempts to regain global confidence in the Chinese economy, one questions if the China Banking Regulatory Commission will work towards forcing banks to correct loan classification process.

Source: 2016 Annual Report (Industrial & Commercial Bank of China, China Construction Bank, Agricultural Bank of China, Bank of China, China Merchants Bank, Bank of Communications, Shanghai Pudong Development, Industrial Bank, Postal Savings Bank, China Minsheng Banking, DBS Group Holdings, OCBC Bank, United Overseas Bank)

Based on annual reports by the banks, Industrial & Commercial Bank of China Ltd’s “ICBC” NPL of 1.6% was much lower than special mention loans of 4.5% of total loans. ICBC’s special mention loans increased by 2.5% from 2% in 2013. In the same report, Bank of China’s special mention loans grew by 3.1%, a startling figure that remains infrequently reported.

The option of auditing these reporting systems is a tougher one than to simply reengineer the classification process. Perhaps it is time to rethink the need for “special mention loan” classification?

Problem loans is also an issue for smaller Chinese commercial banks as they report default rates of more than 20%. In an FT report, analysts shared that debt levels in China are reaching “epidemic” levels.

BBVA economists Xia Le highlighted that risks in these rural banks are highest, insinuating that these banks will fall in the first instance of trouble.

It was reported in the same article that Liuzhou Bank suffered an unprecedented US$4.9 billion loan fraud. This amount was a third of the bank’s assets.