Banks Likely Underreport Bad Debts, State Firm Finds

Banks have likely understated their bad debt, according to one of China’s four national asset management companies (AMCs), which expects nonperforming loans (NPLs) to grow this year as lenders come under more pressure to recognize and dispose of them.

The AMC’s report was a rare acknowledgment from a state-owned company that the official figure for tracking bad debt in the banking system might be underestimated — a view that is widely held outside of China.

China’s bad-debt ratio is likely higher than officially reported, according to conclusions drawn from a data analysis and industry surveys conducted from late November to late December by China Orient Asset Management Co., a state-controlled AMC that has published its report on the country’s bad debt for the last 11 years.

This round of NPLs have formed mainly as a result of economic structural reform, weak risk controls in the financial industry and administrative intervention such as pressuring banks to lend to certain entities, according to China Orient’s report.

With the deepening of supply-side structural reform in China, the risk of loan defaults will climb, increasing the likelihood that NPLs will grow over the next three to five years, according to China Orient’s report, which it released Thursday.

Over the last five quarters, China has reported an average NPL ratio of 1.74% for commercial banks. However, the figure has regularly come in question. In 2016, a central bank survey suggested that the actual ratio was higher than 3% at best and more than 5% at worst, a source from the People’s Bank of China told Caixin earlier.

Bankers had told Caixin that some local government officials have interfered with reporting of nonperforming loans by suggesting or hinting to banks in their jurisdiction that they should conceal the true state of their respective bad debts to ensure the results are in line with national policy of keeping a lid on NPLs.

The NPL ratio at commercial banks has held steady at 1.74% for five consecutive quarters. The total amount of NPLs, however, has steadily climbed as lending has grown over the period. Commercial banks’ outstanding NPLs totaled 1.51 trillion yuan ($240.4 billion), 1.58 trillion yuan, 1.64 trillion yuan, 1.67 trillion yuan, and 1.71 trillion yuan for the five quarters starting with the fourth quarter of 2016, according to data from the China Banking Regulatory Commission.

Ratings agency Fitch Rating has long held the view that NPLs are underreported in China. This is due to “delayed asset impairment recognition, regulatory forbearance, loan rollovers and debt write-offs/disposals,” said Grace Wu, head of China Bank Ratings at Fitch Ratings.

“Banks have shifted loans into nonloan exposures such as investments and receivables to bypass lending restrictions, making it hard to assess their underlying asset quality. Limited transparency also renders NPL analysis in China less meaningful, as a large portion of credit exposure reside off-balance-sheet.”

Contact reporter Liu Xiao (liuxiao@caixin.com)