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September 30, 2015

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Home » Business » Biz Commentary

Bad loans loom large as economy and exports slow

By Wilson Pang | September 30, 2015, Wednesday | Print Edition

A slowing economy and exports as well as liquidity constraints are likely to further drive up non-performing loans in China’s banks and hence their risk exposure. To deal with the challenges of credit deterioration, banks should take a more strategic approach.

Domestic commercial banks in China saw a significant 57 percent year-on-year increase in their NPLs, to 1.09 trillion yuan (US$170.3 billion), by the end of June 2015, data from the China Banking Regulatory Commission show. The ratio of NPLs hit a record high of 1.5 percent as credit quality deteriorated faster than loan growth.

Another alarm bell is seen in special-mention loans, debts that could potentially become non-performing. These rose 62 percent from a year ago to a high of 2.65 trillion yuan, accounting for 3.6 percent of total loan exposure as of June 30, compared with 2.6 percent at the same time last year. If there are no further economic stimulus policies in China and no improvement in export performance, liquidity constraints might boost NPLs, and we predict the ratio might hit 1.8 percent or above by the end of 2015.

Borrowers’ debt servicing and repayment abilities have a strong correlation with the economic cycle, and liquidity in the banking system as well as government policies apply to different business communities.

Due to industrial overcapacity and a liquidity crunch, NPLs are rising in the manufacturing sector, particularly in heavy industries such as steel, cement, plate glass and electrolytic aluminium. They have been impacted by decreasing domestic demand, increasing international trade barriers and tightening environmental requirements. Emerging industries are also affected.

NPLs have now spread across China — from the Yangtze River Delta to Foshan in the Pearl River Delta and Qingdao in the Bohai Rim Area. The recent establishment of five new provincial asset management companies in Shandong, Hubei, Ningxia, Jilin and Guangxi provinces, where commercial activities are not as vibrant as coastal cities, reflects the fact that NPLs are now a nationwide challenge rather than just a regional problem.

China established the “big-four” asset management companies at the tail end of the Asian financial crisis in 1999 to take over the NPLs of the four biggest state-owned banks. Since the beginning of 2013, the China Banking Regulatory Commission has authorized 15 provincial asset-management companies to participate in bad loan transactions across China’s banking sector.

Over the last 18 months, KPMG has been assisting both China and foreign banks to dispose of over 110 NPL portfolios with a face value of more than 100 billion yuan. We’ve also seen a growing number of international investors positioning themselves to capture these loans.

Increasing numbers of asset management companies provide easier access for banks to divest their NPLs. However, banks should not rely on that channel alone.

Controlling the growth of NPLs will require a comprehensive risk management strategy that covers all aspects of the lending cycle. Banks should improve their traditional credit and risk management methodologies, and establish a comprehensive risk alert and management system to handle the entire loan cycle, from credit assessment to credit approval and post-lending management.

Some banks have already taken steps in this direction by attempting to centralize credit and risk management in a single special asset task force, where experienced people can examine problematic accounts and help formulate responses or turnaround strategies.

While these efforts are to be commended, they may not be sufficient in isolation. Any attempt to truly confront the NPL issue will hinge on assessing borrowers at a much earlier stage. This requires front-line staff to consider the realizable value of collateral and to pay closer attention to the cash flow of business borrowers.

The chief risk officers of banks should develop an advanced and proactive system to identify potential dangers before they present a threat to the balance sheet. Banks also need to enhance their existing “big data,” or early-warning system to strengthen their credit and risk assessment for borrowers of different industries and growth phases.

While the traditional recovery approach for problem loans focuses on collection, chief risk officers should devise alternative strategies to maximize recovery and minimize loss. Identifying means for borrower to resolve liquidity issues or potential operational improvements that could put a company on a sounder footing should form the basis of a new philosophy in NPLs management.

Biz Commentary


 

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