China’s plan to rid its banks of bad loans may end up being an exercise of rearranging the deck chairs on the Titanic, if recent deals are any indication.
The idea was to take the non-performing loans (NPLs) on the banks’ balance sheets and repackage them into securities, which would then be sold to risk-hungry investors.
Just one problem, there isn’t a lot of demand for these products. The first deals in this 50 billion yuan ($7.6 billion) program have only managed to shuffle the bad debt between banks, doing little to improve the health of China’s financial system as a whole, reported Bloomberg.
The 301 million yuan debut offering of NPL-backed securities from the Bank of China on May 26 ended up selling more than half to other Chinese lenders, according to people familiar with the matter, who asked not to be identified because they aren’t authorized to speak publicly. This means that 95% of the deal’s riskiest tranche was purchased by a state-owned asset manager, a sign of tepid demand among private institutions. That same day, China Merchants Bank sold at least 60% of a 233 million yuan NPL offering to other banks, people familiar said.
Critics of the program say the securities are too complex and illiquid to attract widespread demand from China’s non-bank institutions.
“We don’t have enough domestic institutional investors with the expertise to price such complex products,” Ming Ming, Beijing-based head of fixed-income research at Citic Securities, China’s largest brokerage, told Bloomberg. “Lack of qualified investors, especially in the junior tranche, will make it hard for banks to sell NPL-backed securities and constrain their development.”
This could prove to be a big problem. If the lenders are unable to get rid of their NPLS, then one of the few options left would be a government-led bailout, which Standard Chartered estimates could cost as much as $1.5 trillion.
Something needs to be done as the flooding of the country with credit over the past decade has built up a huge inventory of bad loans. And this is proving to be one of the biggest risks facing Asia’s largest economy. With its economy slowing down, China has about $2.4 trillion of corporate debt at risk of default, according to Bloomberg Intelligence.