CHINA'S BANKING SYSTEM: When the party’s over

China’s spectacular lending binge has brought into sharp relief the need among lenders to shore up their eroded capital base. But more worrying is a likely surge in non-performing loans that could stretch state finances to the limit

  • By Elliot Wilson
  • 02 May 2010
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The People’s Bank of China’s (PBoC) internal website is hardly a riveting read, but one section tells you more about the country’s leading banks than a thousand analyst reports. Tucked away under ‘Previous Governors’ is a list of former Beijing central bank chiefs, running from 1949 to 2002.

At first glance the page contains little out of the usual, but a second look reveals an apparent programming glitch under the name of Hu Lijiao, the bank’s third governor. Hu took office in October 1964 but never officially left: in August 1966 he was quietly removed from his duties and sent to work in a labour camp in southern Guizhou province. Only after the maddest years of Chairman Mao’s Cultural Revolution had passed, seven years later, did the PBoC reform, this time under the watch of the fourth governor, Chen Xiyu.

China’s financial system has changed out of all proportion since then, but one parallel remains: the identity of those pulling the levers behind the scenes. In the 1960s, power lay squarely in the hands of Mao Zedong. By the second decade of the third millennium, the power had been spread, but thickly, and only within the claustrophobic confines of the Chinese Communist party.

Those who run China’s leading banks – the chairmen and chief executive officers in the higher party echelons – do so only in name. The real power lies with the nine-man Standing Committee, headed by president (and party general secretary) Hu Jintao, and a cabal of 370 old men comprising the Central Committee. When these two bodies tell the banks to jump, they jump. And when they tell their banks to lend, they lend.

So when Beijing, fearing that a global recession would cause upheaval and riots at home, announced a $600 billion fiscal stimulus package in November 2008, party leaders fulfilled their promise of not dipping into the country’s $2.4 trillion foreign reserves, by telling their pet banks to lend heavily.

The banks acquiesced, disbursing an avalanche of loans to leading state-owned enterprises (SOEs), local municipal authorities, and major domestic infrastructure companies, many of them divisions of the country’s 1,407 city councils.


Leading lenders such as Industrial and Commercial Bank of China (ICBC) and Bank of China (BOC) – banks also answerable, in theory, to a coterie of global investors – shelled out $1.4 trillion in new loans in 2009. They are on track to disburse a further $1.1 trillion this year and $800 billion in 2011 – more capital lent by any country’s banking sector in recorded history.

Two disturbing consequences follow upon China’s lending binge. The first is a pressing need among lenders to shore up their eroded capital base. The other is more worrying and inevitable: a likely new surge in non-performing loans (NPLs) that will stretch China’s generous state finances to the limit.

Despite posting brisk profits for the full year 2009, the country’s banks desperately need capital. Directed by party leaders in Beijing, they spent the first quarter of 2010 tapping the Shanghai and Hong Kong markets. In March, Merchants Bank, widely regarded as the country’s best-managed lender, raised Rmb18 billion ($2.63 billion) from mainland investors via Shanghai; the bank is also seeking to raise Rmb4 billion from investors in Hong Kong.

By end-April, two more lenders are expected to have raised fresh capital. Bank of Communications (BoCom) has applied to raise up to Rmb42 billion in Shanghai and Hong Kong, while China Construction Bank, the country’s third-largest lender, is planning to bolster its capital base by selling Rmb75 billion of shares, also in the country’s twin financial centres.

Even ICBC, China’s largest bank by assets, is seeking to raise cash, by selling around Rmb25 billion of bonds convertible into yuan-denominated ‘A’ shares in Shanghai.

Analysts are mixed on China’s dash to raise cash – leading banks need a shot of capital to restore eroded balance sheets, but it also underscores the aggressive lending policies pursued by leading mainland lenders in 2009, and highlights the rigidity with which they remain controlled by the party.

“Banks can raise capital in New York or London in the most troubling environment, but in China the CSRC, the country’s securities regulator, halts any capital raising when it gets worried,” says Bill Stacey, a director at Hong Kong brokerage Aviate Global. “China’s banks aren’t allowed to go to market when they want, or to allow their rights issues to be underwritten. China has to loosen up the strings here – they will hate it as it undermines their power and their patronage, but they have to give the banks more autonomy.”

All the while, China’s forgotten bank bides its time, waiting for the chance to tap domestic and global capital markets for the first time: Agricultural Bank of China (ABC), the last of the big four lenders to sell shares to the public, is hoping to complete a $20–30 billion initial public offering (IPO), probably in Shanghai and Hong Kong, once its rivals have raised enough cash to tide them over.

Reginaldo Cariaso, executive director, equity capital markets, Asia ex-Japan at Nomura says: “Agricultural Bank of China is the big IPO from China that everyone is waiting for over the next 12–15 months.”


China’s looming NPL crisis is, however, of far greater concern. The country’s banks have wiped sour loans off their books twice before, in 1998–99 and again in 2004–05. But this time it is different. On the previous occasions, leading Chinese banks were wholly state-run organs; now they are listed institutions with foreign shareholders, subject (in theory) to higher levels of scrutiny and transparency.

Moreover, the party has never subjected its banks to such a stress test. Much of the lending during 2009 was parcelled out in a slapdash fashion to local city councils and state firms, which in turn pumped cash into local vanity projects likely to generate little substantive return.

Thus, NPL rates could be even higher than the bad loans pumped into state projects in the 1990s, much of which simply lined the pockets of party officials. Some analysts reckon up to one-half of all new 2009 and 2010 bank loans will go sour, costing the state between $1 trillion and $1.5 trillion, a bill that would shred Beijing’s foreign reserves.


Analysts are mixed over how bad the NPL situation will become. Anthony Lok, managing director, research at BOCI International in Hong Kong, believes the situation is manageable. “Loans grew at a steady rate throughout the 2000s,” he says. “The only difference came in 2009, when China had a total loan blowout. But one year of excess spending does not make a bubble. The situation is not as bad as some people are making out.”

Arthur Kroeber, managing director of Beijing-based consultancy Dragonomics says: “An NPL problem is brewing. Of the loans made between 2008 and the end of 2010, one dollar in six will turn into a bad loan that is beyond the bank’s ability to mark down internally.

“The question is whether it is financeable – and I believe the answer is ‘yes’,” he says. “But this only works if between 2011 and 2020 China doesn’t create any more bad loans – or at least it only creates new bad loans that can be provisioned against.”

Kroeber believes the most compelling question is whether China can wean itself off an almost unique process of boom-and-bust. “Will China stop doing this? If they don’t, then in 10 to 15 years’ time China will look much as Japan does today, full of awful debts that can’t be dealt with. I am more optimistic here, as China has a much better track record than Japan at facing up to problems. But they certainly need to work out how to do things better in the future.”

Others are concerned at the impact that higher lending will have on China’s lesser lenders, those who have disbursed loans to second-rate infrastructure projects over the past 18 months.

Gao Jian, vice governor at China Development Bank, the country’s chief policy lender and one of the country’s best-run institutions, says he is most concerned about the impact on China’s smaller banks. “Rising NPLs will hit smaller lenders,” he says. “We have seen this situation in the past with NPLs, though – there are some economists based in Hong Kong who have forecast substantial increases in NPLs in coming years, but I don’t think that will happen.”

Others aren’t so sure. Victor Shih, an assistant professor at Northwestern University in the US, rose to notoriety in early 2010 after calculating local Chinese government debt at around $1.7 trillion – twice the official estimate and one-third of Chinese GDP. The rise, he said, was largely due to vast quantities of capital pumped into city authorities and SOEs by profligate banks – banks that will come to regret their largesse.

“There is a lot of de facto bad loans that are being rolled over by banks,” he says. “Besides special mention loans – troubled loans marked down as ‘failing’ rather than ‘failed’ – one can look for how many short-term loans are being extended as medium- and long-term loans. This suggests that many problematic loans are being extended.”

Party leaders in Beijing are already kicking up a fuss about wayward bank lending, and seeking to rein in credit growth. But the truth is this is what the country does.

China may not be under Mao’s thumb any more, but for the country’s leading banks – now sucking in capital from local and foreign markets while toiling under a burden of new bad loans, both legacies of Communist party edict – the world is surprisingly similar to the 1960s, and the dog days of Hu Lijiao.

  • By Elliot Wilson
  • 02 May 2010

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 18 Jul 2017
1 Citi 244,235.70 910 8.87%
2 JPMorgan 223,767.95 1021 8.13%
3 Bank of America Merrill Lynch 211,276.97 750 7.68%
4 Barclays 166,062.82 634 6.03%
5 Goldman Sachs 162,877.27 537 5.92%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 HSBC 25,385.87 103 7.10%
2 Deutsche Bank 25,125.19 81 7.03%
3 Bank of America Merrill Lynch 22,023.57 59 6.16%
4 BNP Paribas 18,766.65 109 5.25%
5 Credit Agricole CIB 18,157.63 105 5.08%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 18 Jul 2017
1 JPMorgan 12,578.87 55 8.17%
2 Citi 11,338.07 71 7.36%
3 UBS 10,682.06 44 6.93%
4 Goldman Sachs 10,419.53 53 6.76%
5 Morgan Stanley 10,194.88 57 6.62%