China’s bad banks rejig can serve a bigger purpose

China Cinda Asset Management

06/02/2024 04:49

(The author is a Reuters Breakingviews columnist.  The opinions
expressed are his own.)
    By Chan Ka Sing
       HONG KONG, Feb 6 (Reuters Breakingviews) - 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.

    CONTEXT NEWS
    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. 

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Graphic: China has a history of deflationary pressure    https://reut.rs/42vLNjg
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 (Editing by Antony Currie and Katrina Hamlin)
 ((For previous columns by the author, Reuters customers can
click on  CHAN/  
KaSing.Chan@thomsonreuters.com; Reuters Messaging:
KaSing.Chan.thomsonreuters.com@reuters.net))