Dealing with the Bad Loans of the Chinese Banks

Abstract

Although China successfully averted the collapse of the currency system during the recent East Asian crisis, its banking sector is quite fragile measured by undercapitalization, loss-making and huge nonperforming loans (NPLs). The growing financial fragility during the reform period was attributable mainly to the evolving triangular relations among the fiscal system, the state-owned enterprises (SOEs) and the state-owned banks (SOBs). It is estimated that the proportion of NPLs is at least 30 per cent and the costs of completely restructuring the banking sector are about 20 per cent of the GDP. To alleviate the financial risks and build a strong banking system, the Chinese government has recently introduced a set of reform measures including adopting a new accounting system, improving financial supervision and regulation, recapitalizing the SOBs and establishing four asset management companies (AMCs) for dealing with the bad loans. Drawing on the experiences of the Resolution Trust Corporation in the United State and bank restructuring in Central Europe, this study argues that the current AMC approach is unlikely to be successful in resolving the existing NPLs and preventing creation of new NPLs. To solve these problems, a set of new measures is recommended to modify the current approach, including terminating policy loans, introducing private and foreign strategic investors in NPL market, redefining the relationships between the parent banks and the AMCs, and transferring problem enterprises' deposits as well as NPLs from parent banks to AMCs.

JEL Classification: G21, P34