What will the PRC Bank do with their Bad Banks?
Note: For those not in the know, the PRC only delivers PRC –released data. Moody’s, Fitch, and S&P have slightly elevated access, but for the most part everyone receives the same, bad, information.
If you look at China’s consumer funding gap, a useful statistic begotten in finance but still used by the Bank of England to a degree, it looks grim. It’s a statistic I think people should become more comfortable with -- so here it goes – the consumer funding gap is the difference between assets and liabilities in a bank’s balance sheet – i.e. the difference between what it has available to loan out and the surplus, or deficit, of loans outstanding. Hopefully that makes sense.
In China, the consumer funding gap is the only one in the top 10 largest economies to be positive. However, with recent changes signaled by everything from the 12th 5 Year Plan, from 2012, and changes in government (remember, China has local, municipal, state, provincial, and national governments, all of whom are relatively unnetworked beyond being members of the same political party -- so if you go to China to start a business you’ll be expected to start relationships with all five tiers of government, good luck) and means the “private banks” (which are partially owned and run by the party, because all bank managers are Communist Party members) and public banks (which only give loans to public companies to large conglomerates like Haier) have leveled off their liquidity levels to an extent not seen since the late 1990s with increases in short-term real rates, reduction of state-planned deficit-spending from construction of public buildings to highways and would have given them loanable assets to deploy, and disincentives for people buying 2nd apartments and the like mean even less loanable assets to deploy.
This means that if you take a look at the asset sheets of large Chinese banks, do some math, you’ll find that the surplus in the consumer funding gap which should mean that their banking system is very healthy suddenly looks sheepishly desultory and very rotten. Kind of like those shiny Chinese toys given to children that are made out of lead – it will kill you in the long-run but looks fine from the outside.
Unfortunately, with my sources at the PRC Bank (all of whom, by the way, were born to work the bank since their parents too worked too, so there’s a certain amount that cannot be believed due to group think problems) worrying that they can no longer offload their toxic assets and make their balance sheets healthy again beyond giving it to government-sponsored asset management firms.
So what’s the significance of the info? In America, as we know, large banks like JP Morgan can park their liquid assets in the Fed, i.e. bonds and such. This makes the Western financial system soak in the calm, warm waters during an abrupt storm so they emerge and begin loaning out money. However, in the short-term tightens the monetary supply and but keeps reserves as high up as Icarus was before he was shot down but as they crash they’ll have AAA, loanable assets to deploy in the long-term.
In China, banks are unable to park their assets in the PRC Bank. Doing so would mean it would gain through carry (because of higher interest rates in China mean there’s an incentive to just live off of the PRC Bank by storing cash there during the bad times rather than ever loaning it out).
I found your post rather confusing but traditionally the Chinese banks have disposed of their bad loans through regional branches of the four national AMCs. These are the bad banks that buy the NPLs from the banks then proceed to auction them off to private investors, sort of similar to the RTC in the U.S. Thou more recently the AMCs have broadened their service offerings to bond underwriting etc to become more like full service investment banks. Also local AMCs have also been set up, thou these are so far not allowed to sell loans but only supposedly restructure, whatever that means.
The transfer of bad loans to the AMCs allowed the big Chinese banks to clean up their balance sheets and undergo successful IPOs with clean slates. Since then they have been selling off their NPLs to the AMCs on a periodic basis, with waves of large amount of NPLs followed by periods of relative quietness. Right now there is talk that, the banks may simply write off some of their loans right away which enable them to reduce their NPL provisions immediately, rather than going through the process of transferring them to the AMCs.
Also a lot (and many would argue, a majority) of the bad loans are not held on the banks' balance sheets, but rather funneled through high interest loans embedded into trust products that were then sold as wealth management investment products to retail investors. This practice effectively transfers risks from the banks to the individual investors. So far the government has been guaranteeing most of these products but with the chronic duration mismatch of many of those loans some kind of refinancing scheme would have to take place to prevent more trusts from defaulting. Exactly how that can be done and how can private shadow lenders and investors get involved is a very interesting topic.
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