China's banking firms will soon encounter new difficulties in lowering their non-performing loans (NPLs), as the country's financial authorities are further tightening bank credit in a bid to pilot the economy's soft landing.

Major Chinese commercial lenders, including the four biggest state-owned banks and 11 joint-stock banks, witnessed, in the year's first half, the reduction -- substantially -- of their outstanding NPLs and the proportion of their NPLs to total loans.

Recent figures, published by the China Banking Regulatory Commission (CBRC), indicate NPLs at domestic commercial banks dropped 4.44 percentage points since the end of last year. By the end of June, they were 1.66 trillion yuan (US$200 billion), or 13.32 percent of the banks' total loans.

However, that rapid reduction was largely due to the recent disposal of NPLs -- through auctions involving international bidders -- by the Bank of China (BOC), China Construction Bank (CCB) and Bank of Communications.

During the banks' massive disposal of NPLs, BOC wrote off 106.3 billion yuan (US$12.85 billion) worth of bad loans. BOC and CCB transferred a combined 278.7 billion yuan (US$33.68 billion) worth NPLs to state-owned asset management companies.

As a result, the four biggest state-owned banks managed to reduce their bad loans by 16.4 billion yuan (US$1.98 billion) in the year's first half.

In the year's second quarter -- immediately after China's financial authorities issued a series of macroeconomic adjustment policies -- the "big four" saw their NPLs increase 18.3 billion yuan (US$2.21 billion).

Encouraged by the People's Bank of China (PBOC), the nation's central bank, the four largest State-owned lenders aim to reduce their combined NPL ratio to an average of 15 percent by 2006.

If, within two years, the commercial banks manage to bring down their NPL ratio to 10 percent, they will meet the threshold requirement for public listings on foreign stock exchanges.

They will also be better able to compete effectively with foreign banking firms.

The "big four" last year lent aggressively to overheating sectors -- including the automobile, construction materials, steel and oil industries -- and focused on mortgages and consumer loans in a bid to inflate their loans.

The four State-owned banks last year issued a combined US$157 billion in loans. That was equivalent to 11 percent of China's gross domestic product (GDP), indicated a report by global consultancy Ernst & Young China.

The Chinese Government's macroeconomic adjustments, which feature tight bank credit controls, slowed the growth of new bank loans at the country's commercial lenders in the year's first half.

For example, in the second quarter, new loans generated by the Agricultural Bank of China grew 53.1 billion yuan (US$6.42 billion), about 30 percent of its newly added loans in the year's first quarter, when PBOC's credit-tightening measures were comparatively lenient.

Meanwhile, BOC, in the second quarter, witnessed new loans grow by 44.6 billion yuan (US$5.39 billion), about 40 percent of its newly added loans in the year's first quarter.

The reckless expansion of loans by China's commercial lenders has -- since the financial authorities started the recent round of credit-tightening measures earlier this year -- inevitably become their new source of NPLs.

The Chinese Government, to enforce the macroeconomic adjustment measures, has closed down numerous enterprises and stopped investment projects in the overheated sectors.

These administrative measures will cause new bad loans to accumulate at commercial banks, which have either issued loans to these enterprises or have financed these investment projects. Many of China's commercial banks lack sound risk-management and monitoring systems.

At present, bank loans generally make up more than 60 percent of the capital for projects, especially within capital-intensive industries such as iron and steel, aluminium, automobile and property development.

The investment boom in the overheating sectors over the past two years has created huge demand for funds, and resulted in a significant amount of bank loans.

However, PBOC and the government have, since early this year, tightened monetary policy and used administrative measures to tame inflation and cool investments.

The recent fall of business heavyweight Xinjiang Delong Group created billions of yuans of non-performing loans at commercial lenders.

By the end of last year, corporate debts, which were unlikely to be recovered, at China's large enterprises had reached 1.86 trillion yuan (US$224 billion), a year-on-year increase of 16.9 percent. Some 50 percent of large enterprises across the country last year had trouble in repaying bank loans.

While China's asset-management companies are expected to dispose of their entire NPL portfolios by 2009, their efforts to date have generated disappointing results.

The asset-management companies are frustrated that senior managers and regulators must approve their multiple-transaction strategies. In many instances, internal approval of NPL transactions take several months, and regulatory approval takes additional time too, indicates Ernst & Young's report.

Upon their establishment in 1999, China's four largest asset-management companies -- Cinda, Great Wall, Huarong and Orient -- acquired a combined 1.4 trillion yuan (US$168 billion) worth of NPLs from the State-owned commercial banks.

China's financial authorities last year encouraged a pioneering deal by China Huarong AMC to repackage 13.2 billion yuan (US$1.6 billion) worth of NPLs into a trust program.

Commercial banks' capital adequacy ratio must reach 8 percent -- the minimum required by the Basel Capital Accord reached by international banking managers -- in accordance with China's commercial bank law.

The author Yi Xiangrong is an economist with the Chinese Academy of Social Sciences.
 
(China Daily August 10, 2004)