BANKING: Beijing Comes to Banks’ Rescue Again
Bottom line: A new Beijing bailout allowing banks to swap bad loans for shares of defaulting borrowers will only prolong China’s ballooning bad loan crisis, saddling lenders with shares of poorly run companies.
Exactly how many times can Beijing rescue the country’s ailing banks? The answer to that question appears to be “at least one more time”, and most likely quite a few more in the next few years. That’s my latest assessment on reading new reports that Beijing is finalizing yet another plan to relieve the burden of ballooning bad debt weighing on most of the nation’s banks.
I’ll discuss the latest rescue plan shortly, and also add why this particular plan is one of the least attractive I’ve seen so far. But before that, I should use this occasion to say once more how this move shows why Chinese banks aren’t a very good investment. Put simply, most of China’s banks still behave more like policy lenders than real commercial banks, making loans based on directives from Beijing and local government officials.
That kind of behavior is exactly what got the banks into their current mess, since many of the bad loans that are now crippling their balance sheets were made under government orders as part of a massive 4 trillion yuan ($600 billion) economic stimulus plan during the global financial crisis dating back to 2008. Since the government got the banks into this mess, it does seem only fair that it now bails them out.
This kind of cycle means these banks are highly unlikely to fail, since the government will always come in to rescue them in times of trouble. But it also means they probably won’t ever prosper either, since profits aren’t their main driving force. That reality has pushed China’s big 4 state-run banks to very low valuations at present, typified by industry leader ICBC (HKEx: 1398; Shanghai: 601398) that trades at a current price-to-earnings (PE) multiple of just 4, compared with 7 for global peers like Citigroup (NYSE: C).
All that said, let’s return to the latest bailout plan for China’s commercial lenders, most of them mid-sized regional banks. According to the latest reports, Beijing is finalizing the plan that would allow the lenders to take equity stakes in companies that can’t repay their loans. (English article) Thus, for example, if a widget maker can’t repay its loans to ICBC because it’s losing big money, the scheme would allow ICBC to accept shares of the company instead of repayment.
Special Approval Needed
A document detailing the scheme should be released shortly, the reports say. The plan is somewhat contrary to current law, which bars banks from investing in non-financial institutions. To circumvent that issue, the new law will get direct approval from China’s State Council, the equivalent of a cabinet, avoiding the need to revise current banking law.
Bad debt held by Chinese lenders surged to a decade-high last year, with banks holding more than 4 trillion yuan worth of non-performing loans (NPLs) and other loans in danger of imminent default at the end of 2015. Many of the bad loans were made under the Beijing economic stimulus plan, which saw banks lend huge amounts for a wide range of projects aimed at boosting economic activity without much consideration for how the money would be repaid.
This particular rescue package is one of the first to directly address what exactly the banks should do with all their bad debt. Most of the other rescue moves to date have involved injecting new funds into the banks to bolster their balance sheets, usually via sales of new stock and bonds to the central government and other state-owned entities.
This latest plan looks like a step towards addressing the issue of what will happen to all those bad loans. But that said, giving the banks shares of big money-losing companies hardly looks like a good solution. That’s because those shares aren’t likely to be worth much, since most of these companies aren’t really good investments to begin with. Thus the banks could just be swapping out their bad loans for shares of poorly run companies, many of which could ultimately fail.
