China’s bad banks rejig can serve a bigger purpose

There’s more to the prospect of China’s sovereign wealth fund taking control of three of the country’s largest bad-debt managers than meets the eye. The potential deal, outlined in a since-deleted report by state-run Xinhua last week, may solve some regulatory and governance issues. Similar moves in the past led to a cleanup of the financial system’s toxic loans and ultimately helped beat deflation and invigorate economic growth.

China Investment Corporation subsidiary Central Huijin is the biggest investor in state-owned financial assets. Having it take over three of the big four asset management companies [AMCs] – China Cinda 1359.HK, China Orient and China Great Wall – would eliminate a conflict of interest for the Ministry of Finance: it is currently both the regulator and majority shareholder of the AMCs.

History suggests that this is more than a case of moving assets from one state pocket to another, however. The AMCs themselves were created in 1998, under the finance ministry’s auspices, to mop up some 1.4 trillion yuan ($200 billion) of bad assets from insolvent state lenders. The central bank provided some of the financing, with a guarantee from the state which in addition raised 270 billion yuan via the bond market to recapitalise the banks. By 2003 lenders required another handout. This time the AMCs absorbed soured assets that were worth nearly 800 billion yuan. More importantly, Beijing injected $200 billion of the country’s foreign exchange reserves to create Central Huijin, which in turn channelled the money to major banks and became their biggest shareholder.

The debt restructuring essentially replaced toxic assets on major banks’ books with assets backed by the sovereign credit rating. This reinvigorated a dysfunctional banking system, which in turn dragged the economy out of a potential deflationary spiral during 1998 to 2002. GDP growth in real terms, rebounded from below 8% in 1998 to double digit in 2003.

It would make sense to adapt the playbook for the current situation. Sure, this time round big bank balance sheets look healthy. The sector’s non-performing loan ratio stands at 1.62%, per official data, compared with nearly 40% in 1998. Yet China’s overall balance sheet problem is also more complex and much bigger now. Local governments have amassed about 110 trillion yuan of debt, of which over 40 trillion yuan are in various local government financing vehicles, per the IMF. If a third of the off-balance sheet liabilities turned sour, the IMF warned, Chinese lenders would need to take 3 trillion yuan in impairment charges. Investors, too, are concerned that banks’ loan portfolios are not as sturdy as they seem: China’s big four state lenders trade at a 45% discount to book value.

A deal to shunt the three AMCs into Central Huijin could well be the first step to a new bailout of bad loans in the system. Past experience shows it can work in the short and even medium term. Longer-term success, though, means not just passing the bad-debt parcel around, but trying to keep the financial system free of excess. That’s a tall order.

China plans to incorporate three of its four biggest asset management companies (AMCs) into sovereign wealth fund China Investment Corp (CIC) in a move to reform its financial institutions, state-run Xinhua Finance News reported on Jan. 28. The report, which was taken down from the news agency’s website site on Jan. 30, named China Cinda Asset Management, China Orient Asset Management and China Great Wall Asset Management as the AMCs that would be part of the deal.

The fourth, once known as China Huarong, was taken over by state-owned financial conglomerate Citic Group in 2021 and was last week renamed China Citic Financial Asset Management.

The big-four AMCs were created in the late 1990s to take non-performing assets off major state-owned banks’ balance sheets. The Ministry of Finance is the biggest shareholder of the AMCs.
Source: Reuters (Editing by Antony Currie and Katrina Hamlin)