Debt issues plague China’s banks

Bank of Jiujiang, a mid-tier Chinese bank, recently made the rare disclosure that its profits for 2023 may plummet by 30% due to poorly performing loans. This type of transparency is uncommon among Chinese banks, which often try to hide their bad debts through complex arrangements with asset-management companies (AMCs). These agreements allow the AMCs to purchase the toxic loans while avoiding the associated credit risks.

However, regulators are cracking down on such practices, with the new National Administration of Financial Regulation (NAFR) imposing penalties on financial institutions for mishandling debts. The NAFR, established last year, has stronger enforcement capabilities than its predecessors and is taking a more serious approach to the concealment of bad debts.

The increased scrutiny can be attributed to past failures in oversight that led to the collapse of several banks starting in 2019. In response to these challenges, regulators have been pushing banks to be more transparent about their bad debts. This has led to a surge in reported undesirable loans, such as Bank of Jiujiang’s bad loans increasing seven-fold over the past few years.

However, the process of recognizing and dealing with bad debts is complex and can weaken banks’ balance sheets. Local governments may recapitalize banks to help write off bad debts, but the effectiveness of such measures is questionable. Centrally controlled AMCs, originally created to handle bad debts, are now struggling. Some have required bailouts, while others are capital-constrained and buying fewer bad debts despite their increasing prevalence.

In January, reports indicated that three state AMCs would be merged with China’s sovereign wealth fund due to their financial distress. This development is concerning for banks like Bank of Jiujiang, as it signals a potential lack of support for addressing bad debts. The situation poses a significant risk to the stability of the financial sector in China.

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