Chinese Banks Are Worse Off Than You Think

Feuer Frei! · 07-24-11, 06:26 AM

Investors are worried about the health of China’s banks. They’re afraid—with good reason—that the massive, state-directed lending binge that was instrumental in pumping up China’s GDP figures the past two and a half years will end up producing an equally massive pile of bad debt. Barely a week goes by without new word of a troubled project or impending default.
Never fear, say the banks and some analysts. They point to the extraordinarily low loan-to-deposit ratios of Chinese banks, averaging around 65%, as evidence that these banks have plenty of cash to cushion themselves against any future loan losses they might suffer. Everything is under control.
This argument is misleading, and offers a false sense of comfort.

First of all, the loan-to-deposit ratio is a measure of liquidity, not of solvency. A high ratio suggests that a bank may be relying too much on volatile short-term borrowing rather than stable long-term customers to fund its lending. It risks getting caught without enough cash reserves on hand to satisfy its creditors, forcing it to sell other assets at a loss, which could eventually cause the bank to fail. Having plenty of cash reserves on the left (asset) side of a bank’s balance sheet can help prevent such a crisis. But it has nothing to do with a bank’s capacity to absorb losses from bad loans without going bankrupt.
A bank’s solvency in the face of losses depends on the loan-loss provisions it has set aside and the capital it has built up on the right (equity) side of its balance sheet. Chinese banks like to boast that they have an average “loan-loss coverage ratio”—the amount of equity set aside, divided by the amount of nonperforming loans—of 220%, up from 80% at the end of 2008. Optimists argue this shows banks have set aside more than twice the amount of equity they would need to make up for all their bad loans.
But that ratio considers only those loans a bank has formally designated as nonperforming, and banks have hardly recognized any bad loans stemming from their recent bout of lending. China’s banks are required to set aside loan-loss reserves equivalent to 2.5% of their total loan portfolios. Yet based on the lessons of previous rounds of credit expansion, it’s more likely that up to 20% or even 30% of their loan portfolios will turn bad at some point in the wake of the latest expansion.

Indeed, estimates leaked by Chinese bank regulators suggest that 23% of loans to local government-sponsored infrastructure projects are an outright loss, with another 50% at risk of cash default. If Chinese banks made appropriate provision for these losses alone, it would reverse the record earnings they have been reporting and eat into their capital base. Apply these estimates across other risky loan categories, such as real-estate development and business lending diverted to speculation in stocks or property, and their capital is in real danger of being wiped out. The loan-to-deposit ratio doesn’t matter; they can have captive deposits and lots of cash, and still be bankrupt if they threw it all away on bad loans.
In fact, all that excess liquidity Chinese banks have on their balance sheets is really part of the problem. It isn’t there because the banks are cautious lenders, but because China’s external imbalances—the inflow of money from both the current and capital accounts, accumulated as foreign-exchange reserves—keeps driving up the domestic deposit base.
Unless this constant injection of money is sterilized and kept out of circulation, with cash reserves piling up and the loan-to-deposit ratio pushed ever lower, the result is runaway lending. That is precisely what happened when banks were allowed to draw on their reserves to fund the lending boom. The high levels of liquidity in China’s banks aren’t a cushion against bad debt. They are the reason those banks loaned money so recklessly in the first place.

SOURCE

Torplexed · 07-24-11, 08:31 AM

Ever get the spooky feeling that the entire global financial & banking system is just a massive skyscraper of playing cards waiting for someone to finally sneeze?

mookiemookie · 07-24-11, 09:17 AM

Anyone that trusts any "official" economic data out of China to be even close to reality is a fool. China has been proven to be manipulating their GDP figures by embarking on massive construction projects for cities that no one lives in. Building for the sake of building GDP.

TorpX · 07-24-11, 02:22 PM

Quote:

Originally Posted by Torplexed

Ever get the spooky feeling that the entire global financial & banking system is just a massive skyscraper of playing cards waiting for someone to finally sneeze?

This is my thought.

I think this all comes down to human nature. Leaders, whether in China, the US, or Europe, always find it easier to sweep problems under the rug, than to fix them. Trust us, we know what we are doing. Everything is ok. But, we have already seen this is not the case. I have no confidence in their leaders, or ours. The more power and wealth they obtain, the bigger the mess they make.

TarJak · 07-25-11, 05:53 AM

A lot of people forget that the Chinese boom is largely funded by Government "stimulus". (Read printing money), Does that sound familiar to anyone?

The whole thing is based on trust that someone else is going to pay the piper and unfortunately I can hear him whistling in the wings.

It won;t be long before we have another debt crisis much larger and harder to recover from than the 1929 crash.

07-24-11, 06:26 AM	#1
Feuer Frei! Navy Seal Join Date: Sep 2009 Location: Valhalla Posts: 5,295 Downloads: 141 Uploads: 17	Chinese Banks Are Worse Off Than You Think Investors are worried about the health of China’s banks. They’re afraid—with good reason—that the massive, state-directed lending binge that was instrumental in pumping up China’s GDP figures the past two and a half years will end up producing an equally massive pile of bad debt. Barely a week goes by without new word of a troubled project or impending default. Never fear, say the banks and some analysts. They point to the extraordinarily low loan-to-deposit ratios of Chinese banks, averaging around 65%, as evidence that these banks have plenty of cash to cushion themselves against any future loan losses they might suffer. Everything is under control. This argument is misleading, and offers a false sense of comfort. First of all, the loan-to-deposit ratio is a measure of liquidity, not of solvency. A high ratio suggests that a bank may be relying too much on volatile short-term borrowing rather than stable long-term customers to fund its lending. It risks getting caught without enough cash reserves on hand to satisfy its creditors, forcing it to sell other assets at a loss, which could eventually cause the bank to fail. Having plenty of cash reserves on the left (asset) side of a bank’s balance sheet can help prevent such a crisis. But it has nothing to do with a bank’s capacity to absorb losses from bad loans without going bankrupt. A bank’s solvency in the face of losses depends on the loan-loss provisions it has set aside and the capital it has built up on the right (equity) side of its balance sheet. Chinese banks like to boast that they have an average “loan-loss coverage ratio”—the amount of equity set aside, divided by the amount of nonperforming loans—of 220%, up from 80% at the end of 2008. Optimists argue this shows banks have set aside more than twice the amount of equity they would need to make up for all their bad loans. But that ratio considers only those loans a bank has formally designated as nonperforming, and banks have hardly recognized any bad loans stemming from their recent bout of lending. China’s banks are required to set aside loan-loss reserves equivalent to 2.5% of their total loan portfolios. Yet based on the lessons of previous rounds of credit expansion, it’s more likely that up to 20% or even 30% of their loan portfolios will turn bad at some point in the wake of the latest expansion. Indeed, estimates leaked by Chinese bank regulators suggest that 23% of loans to local government-sponsored infrastructure projects are an outright loss, with another 50% at risk of cash default. If Chinese banks made appropriate provision for these losses alone, it would reverse the record earnings they have been reporting and eat into their capital base. Apply these estimates across other risky loan categories, such as real-estate development and business lending diverted to speculation in stocks or property, and their capital is in real danger of being wiped out. The loan-to-deposit ratio doesn’t matter; they can have captive deposits and lots of cash, and still be bankrupt if they threw it all away on bad loans. In fact, all that excess liquidity Chinese banks have on their balance sheets is really part of the problem. It isn’t there because the banks are cautious lenders, but because China’s external imbalances—the inflow of money from both the current and capital accounts, accumulated as foreign-exchange reserves—keeps driving up the domestic deposit base. Unless this constant injection of money is sterilized and kept out of circulation, with cash reserves piling up and the loan-to-deposit ratio pushed ever lower, the result is runaway lending. That is precisely what happened when banks were allowed to draw on their reserves to fund the lending boom. The high levels of liquidity in China’s banks aren’t a cushion against bad debt. They are the reason those banks loaned money so recklessly in the first place. SOURCE __________________ "History is the lies that the victors agree on"- Napoleon LINK TO MY SH 3 MODS

07-24-11, 08:31 AM	#2
Torplexed Let's Sink Sumptin' ! Join Date: Dec 2001 Location: Seattle, WA Posts: 5,823 Downloads: 43 Uploads: 0	Ever get the spooky feeling that the entire global financial & banking system is just a massive skyscraper of playing cards waiting for someone to finally sneeze? __________________ --Mobilis in Mobili--

07-24-11, 09:17 AM	#3
mookiemookie Navy Seal Join Date: Nov 2005 Location: Houston, TX Posts: 9,404 Downloads: 105 Uploads: 1	Anyone that trusts any "official" economic data out of China to be even close to reality is a fool. China has been proven to be manipulating their GDP figures by embarking on massive construction projects for cities that no one lives in. Building for the sake of building GDP. __________________ They don’t think it be like it is, but it do. Want more U-boat Kaleun portraits for your SH3 Commander Profiles? Download the SH3 Commander Portrait Pack here.

07-25-11, 05:53 AM	#5
TarJak Fleet Admiral Join Date: Jul 2006 Location: Sydney, Australia Posts: 17,052 Downloads: 150 Uploads: 8	A lot of people forget that the Chinese boom is largely funded by Government "stimulus". (Read printing money), Does that sound familiar to anyone? The whole thing is based on trust that someone else is going to pay the piper and unfortunately I can hear him whistling in the wings. It won;t be long before we have another debt crisis much larger and harder to recover from than the 1929 crash.