Are big banks in China undergoing a complete overhaul in their loan transparency disclosures after the latest announcement of several large write-offs of non-performing loans?

In an online Bloomberg News article, dated, October 23, 2013, entitled, “Top China Banks Triple Debt Write-Offs as Defaults loom”, it was reported that several top Mainland-Chinese banks have started to triple their amount of non-performing loans during the first-half of the year in anticipation of what might be a signal of a new fresh face of defaults for many months to come. The issue of writing off bad loans is quite a significant event, as it is a common practice that many of these Mainland Chinese banks do not undertake their loan-loss provisions until these banks have exhausted their various efforts to collect the necessary loan payments, and the banks have to take on the burden of writing off these bad loans. Moreover, it is reported that the practice of writing off loans requires various approvals, namely the Finance Ministry to remove the debt from their books. In most cases, a court hearing has to be conducted in order to seek a declaration of bankruptcy of the borrower by the presiding judge before the banks are allowed to write off the bad loans. I believe that due to the various procedures needed to get approval for writing off bad loans, the costs triumph the benefits, thus these Mainland Chinese banks may decide to defer the write-offs, which resulted in piling up of issues as it encounters with the issues of non-performing loans, and other credit risks that accompany through such deferment of loan write-offs.

According to the Bloomberg News report, the China Banking Regulatory Commission, which was led by Mr. Shang Fulin, has notified big Mainland Chinese banks to set aside more provisions to cover potential huge debt write-offs in April 2013. One of the intents of the new ruling was to enforce tight regulations on the banks’ loan policies, and maintaining prudence in view of the expected slowdown in the domestic and global economies. The Chinese regulatory agency has also enforced tight regulations on dividend payments to ensure that debt holders’ interests are not being compromised behind the directors and shareholders’ interests.

As discussed in my previous write-ups, I believe that these new developments taking place in several of the major Mainland Chinese banks in in alignment with the overall government policy of gradually restoring some form of transparency, and to tighten loan disclosure regulations that conform with international practices, including Basel II and Basel III, which has since been in put in place by many rival financial institutions across the globe. As China is gradually undergoing several major demographic and migration pattern shifts, I believe that China is hoping to gain acceptance among the wider investor communities about its level of commitment through tight enforcement policies on the amount loan provisions taken by these Mainland Chinese banks.

China is also planning to embark on the next 10-years with a plenary session scheduled to be held in Beijing during the month of November 2013, where various top Chinese leaders, including the President and Premier, are expected to meet and discuss how to plot China’s growth in the next few years. China is also aware of its high debt to GDP ratio (current average is approximately 207.0 percent), and its impact on foreign investors’ sentiments on the long-run stability of China’s overall growth going forward.

According to the Bloomberg news report, it was also reported that five of the largest lenders have set aside 272.0 precent of their bad debts, which surpassed the minimum requirement of 150.0 percent mandated by the Mainland Chinese regulators. Several analyst interviewed by Bloomberg News applauded the latest moves towards greater transparency and disclosures being shown by the big Mainland Chinese banks. However, I believe that potential motives underlying such write-offs include better profit figures that might exceed market expectations next quarter or next year. This is commonly known in financial literature as ‘Big-Bath’ accounting. Although the entire process of writing bad loans, or setting aside large provisions if the loan is classified as ‘sour’ conform to international accounting practices, analysts might not be impressed by the larger than expected profits in the years to come, as the comparisons are based on a low base year previously when banks and companies reported low to negative earnings. Moreover, analysts might also take the view that banks and companies are in a position to selectively report favourable or unfavourable earnings results in order to gain investor confidence, and potential tax allowances for those credit losses incurred.

In the most recent earnings releases by these Mainland Chinese banks, the five biggest including Agricultural Bank of China Ltd., Bank of China Ltd., and Bank of Communications Co. have posted a combined total of 22.4 billion Chinese Yuan increase in nonperforming loans during the first half of 2013 to 349.9 billion Chinese Yuan, or approximately 1.0 percent of total loans. This statistic was compiled by Bloomberg News. These major Mainland Chinese banks have also reportedly added 83.1 billion Chinese Yuan set aside as provisions, versus with the 72.9 billion Chinese Yuan during the six months ended June 2012.

In conclusion, I believe that the practice of setting aside provisions and writing off bad loans are timely as China embarks on the next lap of growth. Given the gradual liberalisation of its banking sector, including the creation of off shore Chinese Yuan denominated trading hubs around the globe, and allowing foreign investors to participate in the debt and capital markets in the Mainland, such banking reforms, however small may be, is a sign that China is gradually moving towards becoming a major financial hub. However, with the large provisions and write-offs of bad loans, it also indicates that severity of the slowdown of the overall Chinese economy, and the pace of bankruptcies happening. In addition, the Bloomberg News report have also indicated that the number of bankruptcy cases, personal and business, have soared, with the eastern province of Zhejiang, a region south of Shanghai that’s home to many of China’s largest private companies, reported the most number of bankruptcy cases, including 143 bankruptcy petitions being filed as of 2012, and the figure was almost twice as much as in 2011.

About Hock Meng Tay - Chief Editor, Asia-Pacific Region

Hock Meng Tay, CAIA has written 181 post in this blog.

Chief Editor, Asia-Pacific Region Hock Meng Tay is a CAIA holder and is currently taking CFA qualification. He has over 10 years of experience working as research associate in several investment companies.He is an expert in financial analysis and has published research reports in his current role. He obtained his Masters of Business Administration in Integrated Management and Masters of Arts in Economics while serving his internship in Starsource Inc